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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 2054
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ to ______________ .
COMMISSION FILE NUMBER 000-20873
CONNECT, INC.
(Exact Name of Registrant as Specified in Its Charter)
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DELAWARE 77-0431045
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
CONNECT, INC.
515 ELLIS STREET
MOUNTAIN VIEW, CA 94043-2242
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (415) 254-4000
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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [_]
As of February 28, 1997, there were 18,747,243 shares of Registrant's common
stock outstanding and the aggregate market value of such shares held by non-
affiliates of the Registrant (based upon the closing sale price of such shares
on the Nasdaq National Market on February 28, 1997) was approximately $34.2
million. Shares of Registrant's common stock held by each executive officer
and director and by each entity that own 5% more of the Registrant's
outstanding common stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
Designated portions of the following documents are incorporated by reference
into this Form 10-K where indicated:
Portions of the CONNECT Inc. "Proxy Statement" for the 1997 Annual Meeting
of Stockholders to be held on May 29, 1997 are incorporated by reference into
Part III of this Form 10-K.
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PART I.
ITEM 1. BUSINESS
BUSINESS
This description contains certain forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from the results discussed in the forward-looking statements as a result of
certain of the risk factors set forth below and elsewhere in this Form 10-K.
The Company assumes no obligation to update any forward-looking statements
contained herein.
OVERVIEW
CONNECT designs, develops, markets and supports industrial strength,
scaleable software applications for Internet-based interactive commerce.
CONNECT application software and services are designed to reduce the time and
overall cost for businesses to implement and maintain a secure sales,
marketing, order capture, customer service and procurement capability on the
World Wide Web (the "Web"). The Company's software supports key functions
necessary for large-scale interactive commerce, including user registration,
multimedia catalog and content management, dynamic merchandising, order
capture and management, security, payment processing, customer service,
procurement management, enterprise integration and systems administration.
CONNECT's core product, OneServer(TM), is a cross-industry packaged software
application for Internet-based interactive commerce, including sales,
marketing, order capture, customer service and procurement. In addition, the
Company offers OrderStream(TM), its first preconfigured implementation of
OneServer for business-to-business interactive commerce in selected vertical
markets. CONNECT's applications are designed to support large numbers of
purchasers, products and transactions. The Company's object-oriented software
architecture and robust transaction manager tightly integrate OneServer and
OrderStream with a relational database to provide increased system performance
and transaction capacity. The Company and its partners offer a broad range of
services to implement, support and operate CONNECT's applications.
The Company's products and services offer the following benefits:
. Faster Time to Market. The Company believes that rapid implementation is
critical to success in the Internet-based interactive commerce
applications market. The Company's software incorporates key functions
designed to permit rapid implementation, including user registration,
advertising, multimedia catalog and content management, dynamic
merchandising, browsing and searching, order capture, order management,
usage tracking, security, payment processing, enterprise integration, and
system administration. OneServer's HTML (Hypertext Markup Language)
template engine and business object architecture minimize the need for
custom software code, allowing rapid implementation to meet a company's
specific requirements. To further accelerate time to market, the Company
intends to develop a set of preconfigured application modules of
OneServer tailored to meet the interactive commerce requirements of
selected vertical markets.
In addition, the Company recently launched a new program, CONNECT
QuickStart(TM), to accelerate customer application implementations.
CONNECT QuickStart is directed at companies who wish to take a phased
approach to interactive commerce --creating a live, revenue-generating
Web site as quickly as possible with less assistance, reduced transaction
capacity and reduced initial license fees. Customers can then scale the
application, adding more transaction capacity at a later date for an
additional license fee
. Lower Cost of Ownership. CONNECT's solution is designed to reduce the
overall cost of deploying and maintaining an Internet-based interactive
commerce application. The Company's open architecture, pre-built
functions and integrated approach limit custom coding, thereby reducing
implementation and ongoing maintenance costs.
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. Industrial Strength, Scaleable Applications. The Company's applications
are designed to support large numbers of purchasers, products and
transactions and are based on a foundation of industry-standard
technology. The Company's software can be integrated with existing
enterprise systems and business processes, offers state-of-the-art
security and supports the critical requirements for high capacity
interactive commerce.
PRODUCTS AND SERVICES
OneServer
CONNECT's core product, OneServer, is a software application for Internet-
based interactive commerce. OneServer integrates the key features and
functions necessary to implement a Virtual Sales Channel. CONNECT's customers
license OneServer and, using the Company's professional services capabilities
or those of a Solution Partner, tailor OneServer to the specific needs of
their businesses. OneServer is designed to enable CONNECT's customers to
quickly, securely and cost-effectively implement an Internet-based sales,
marketing, and order capture capability. For sellers, benefits include more
control over order execution, customer specific promotions, better product and
pricing information and tighter relationships with purchasers. The key
business benefits for purchasers include expedited purchasing, lower cost and
24-hour availability.
OneServer Version 1.0 was commercially released in September 1995, and
Version 2.0 was released in beta status in February 1997. Commercial release
is scheduled by April 15, 1997
The Company has licensed its OneServer software to customers for fees
ranging from approximately $100,000 to over a $1 million. Fees for
professional services and annual fees for maintenance and support are
additional. The amount of revenue derived from a particular sale depends upon
a number of factors including the number of computer processors, complexity of
the customer application supported, amount of necessary customization and
other factors.
OrderStream
OrderStream is a preconfigured implementation of OneServer tailored for
business-to-business interactive commerce in selected vertical markets. These
vertical markets include resellers and distributors of computer hardware and
software, electronic components and office equipment and supplies. OrderStream
includes pre-built OneServer business objects and a set of preconfigured HTML
templates (Web pages) designed to support the specific requirements of these
markets. OrderStream version 1.0 was commercially released in June 1996.
Version 1.1 was commercially released in December 1996.
OrderStream includes the following features in addition to those provided by
its OneServer foundation:
<TABLE>
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BUSINESS PROCESS ADDITIONAL ORDERSTREAM FUNCTIONALITY
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<C> <S>
Marketing and Merchandising . Customer-specific catalog and pricing
. Feature-specific product search
. Automated catalog creation and update through
bulk data importation
. User interface screens for catalog, SKU and
product management
. Seller-branded product catalogs
. Custom product designations (e.g., preferred
items and required approvals)
Sales and Order Management . Real-time inventory availability checking
. User interface screens for customer service
and order capture
. Order review, routing, approval and rejection
. Order status tracking
. Purchase controls by buyer, frequency and
dollar amount
Administration and Integration . OrderStream-specific APIs (e.g., inventory
availability and order status)
. Electronic data interchange (EDI)
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The Company licenses OrderStream at a premium to OneServer license fees.
Each OrderStream license includes a OneServer run-time sublicense. As with
OneServer, the Company charges separately for professional services and annual
fees for maintenance and support. The amount of revenue derived from a
particular sale depends on a number of factors, including the number of
computer processors, complexity of the customer application supported, amount
of necessary customization and other factors.
Services
The Company provides a full range of services to support the licensing of
its software applications. These services include project implementation and
training, maintenance and support, system hosting and online services. To
retain its focus on technology and software development, the Company leverages
its own capabilities through relationships with leading third-party providers
of systems integration and design services. The Company believes that the
quality and breadth of these services are an important competitive advantage.
Implementation and Training. The Company offers fee-based services to help
customers design and implement OneServer and OrderStream applications. The
Company and its Solution Partners work closely with customers to clarify the
project business case, define project scope and establish a project plan and
schedule. In addition, the Company offers fee-based education and training on
the use of its products to customers and third-party implementation partners.
Maintenance and Support. The Company provides software maintenance including
product updates and technical support to its customers and Solutions Partners.
Fees charged depend upon the support level and size of the customer's
application.
Hosting Services. CONNECT offers system hosting services for its customers'
OneServer and OrderStream applications. These services include installing the
application on a remote server located at CONNECT's headquarters or a Solution
Partner's site, maintaining and administering the database, and other system
management services. The Company provides these services on a fee basis to
customers who do not want to operate and manage their own Internet-based
applications. The Company is actively recruiting Solutions Partners to provide
such hosting services.
Online Services. Since 1988, the Company has provided private online
services to various businesses and other organizations. These services include
e-mail, user forums and access to public and private information resources and
are marketed under the CONNECT Online brand name. These services may be
accessed by registered users through the Web or proprietary client software.
As of December 31, 1996, approximately 15,000 users in multiple organizations
were using these services.
Licensing and Third-Party Software
The Company typically provides its software products to its customers under
nonexclusive object code licenses. Generally, CONNECT sublicenses to its
customers third-party software integrated in the Company's software, including
a relational database management system from Oracle, a web server from
Netscape, a text search engine from Fulcrum and encryption technology from
RSA. In addition, the Company bundles certain reporting software from COGNOS
with each copy of OneServer. The Company's customers also may obtain such
licenses directly from such third-party software vendors. See "Risk Factors--
Dependence upon Certain Licenses."
CUSTOMERS
As of December 31, 1996, CONNECT had licensed either OneServer or
OrderStream to over 20 customers. The Company commenced marketing its
OrderStream product in May 1996.
There can be no assurance that the applications that have not yet been
implemented will be deployed on a timely basis. Delays on implementation could
have an adverse effect on the Company's revenues and results of operations.
See "Risk Factors".
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During 1996, one company accounted for approximately 13% of the Company's
revenue. No other customer accounted for more than 10% of the Company's
revenue in 1995 or 1996. During 1995, AT&T accounted for 52% of the Company's
revenue pursuant to a contract software development project.
TECHNOLOGY
The Company's technology represents a third generation software architecture
based on the Company's experience in the online services market. The Company's
software architecture is comprised of six tightly integrated layers.
Client Support. OneServer works with leading Web browsers and supports HTML
and Web standards such as HTTP (Hypertext Transfer Protocol) and SSL (Secure
Sockets Layer), an encryption-based security protocol. In addition, for more
complex applications, OneServer supports Microsoft's Visual Basic, ActiveX and
Visual C++ programming languages, as well as Sun Microsystems' Java, a
network-specific programming language.
HTML Template Engine. The OneServer HTML Template Engine separates the
management of database content from the presentation format. The HTML Template
Engine combined with the Object Manager reduces the amount of custom code and
CGI (Common Gateway Interface, a standard for interfacing external
applications with information servers) scripting needed to dynamically create
HTML pages, thereby improving time to market, lowering maintenance costs and
improving system performance.
Transaction Manager. OneServer's Transaction Manager offers robust security
and authentication protection. The Transaction Manager features multi-
processing and multi-threading, thereby enabling OneServer and OrderStream to
scale across multiple processors to accommodate large numbers of purchasers,
products and transactions. In addition, the Transaction Manager ensures
application-wide data consistency regardless of data type (e.g., text, graphic
and structured), and includes the Company's RAMP (Reprioritizable Asynchronous
Multi-threaded Protocol), a client/server protocol for handling transactions,
as well as a transaction dispatcher and monitor.
Business Objects. OneServer includes pre-packaged business functionality or
objects designed for use in interactive commerce. Customers can extend these
objects or build new objects quickly and easily to match precise business
requirements. The pre-packaged objects support common sales and marketing and
other business functions including user registration, advertising, multimedia
catalog and content management, dynamic merchandising, browsing and searching,
order management, security and authorization, transaction processing,
enterprise integration and system administration.
Object Manager. The OneServer Object Manager defines and manages objects
thereby extending the capabilities of the Oracle 7 database to handle custom
and predefined objects, including multimedia objects. These capabilities are
designed to allow customers to create robust, complex and flexible data
models. The Object Manager hides storage and access complexities, allowing the
customer to focus on automating business processes. The Object Manager allows
objects to be extended by inheriting characteristics from multiple parent
objects, reducing data redundancies and extraneous coding requirements. An
object's attributes can be accessed through the Internet-based URL reference
instead of custom code.
Industry Standard Technology. OneServer incorporates industry-leading
technology as part of its architecture, including the Oracle 7 relational
database management system, the Netscape Enterprise Server web server, the
Fulcrum text search engine and RSA encryption. The tight integration between
the Oracle 7 database and OneServer results in increased system performance
and transaction capacity. The Company's software applications run on the HP-UX
10 and Sun Solaris 2.4/2.5 versions of the UNIX operating system.
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MARKETING AND SALES
CONNECT's marketing efforts are focused on increasing awareness of CONNECT
and its products in selected target markets, and positioning CONNECT as a
leading interactive commerce software provider. CONNECT marketing programs
have four primary goals: lead generation, market education and awareness,
sales effectiveness and product management. The Company's market education and
awareness activities include seminars, speaking engagements and sponsorship of
market studies by leading industry analysts. In addition, CONNECT utilizes
direct mail, public relations, trade shows, telemarketing and innovative sales
tools to disseminate its marketing message, generate sales leads, and improve
sales effectiveness. CONNECT's product management staff works with customers
and industry experts to ensure that the Company's products will satisfy market
requirements.
The Company currently sells its products and related services using two
channels: a direct sales model and a "leveraged" direct sales model (using
leads referred by Solution Partners). The Company's selling efforts generally
focus on senior level executives in large corporations. The Company intends to
expand distribution of its OneServer product in the future to include indirect
sales channels, such as value-added resellers (VARs).
The Company markets and sells its products and services through an
organization consisting of 43 employees as of December 31, 1996, based at the
Company's corporate office in Mountain View, California, and offices in Oak
Brook Terrace, Illinois; Stamford, Connecticut; Dallas, Texas; and London,
Great Britain.
SOLUTION PARTNERS
A key element of the Company's strategy is to continue to expand its
strategic alliances with Solution Partners. The Company believes that such
relationships promote the visibility of the OneServer and OrderStream
applications and enable the Company to supplement its core products and
services to provide a complete solution. The Company's Solution Partners can
be segmented into the following four categories:
Technology Providers. CONNECT has incorporated industry-leading software
into its products. The Company licenses and resells software from Oracle
(relational database management system), Fulcrum (text search engine) and RSA
(encryption). The Company has plans to include Netscape's webserver in future
releases of its products. The Company also engages in joint marketing
activities with other technology companies, including Hewlett-Packard and Sun
Microsystems.
Solution Enhancement. CONNECT is working with other companies that offer
additional complementary solution elements. These include First Data
Corporation (payment processing), CyberCash, Inc. (payment processing),
Verisign, Inc. (authentication), COGNOS (reporting tools), and BBN Planet
Corporation (Internet access).
Professional Services. CONNECT works with a group of leading professional
services organizations to assist customers in implementing OneServer and
OrderStream. These organizations are Ernst & Young LLP, Andersen Consulting,
Computer Sciences Corporation, Compuware Corporation, Logica plc, Sage
Solutions, Inc., Sapient Technologies, Inc. and Cambridge Technology Partners.
These providers perform services such as business process reengineering and
integration, database design and application development.
Creative Partners. CONNECT works with organizations that specialize in the
creative aspects of developing Web sites. These organizations include CKS
Partners Ltd., Eagle River Interactive Inc., Poppe Tyson Advertising & Public
Relations, Ikonic Interactive Inc., Organic Online, Studio Archetype (formerly
Clement Mok Designs, Inc.) and Thomas Nicholson. These firms are an important
initial contact point for companies exploring interactive commerce
applications and are sometimes sources of referrals for the Company.
RESEARCH AND DEVELOPMENT
Since inception, the Company has made substantial investments in research
and product development. The Company's research and development expenses were
$4.7 million in 1996, $4.8 million in 1995, and $1.6 million in 1994, and the
Company expects to increase research and development expenses in 1997. The
Company's
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current software products have been developed primarily by its internal
product development staff. A significant portion of the Company's development
efforts during 1994 and 1995 were performed under the Development Projects. In
general, under these Development Projects the Company retained ownership of
the technology being developed subject, in certain cases, to nonexclusive
licenses granted to the Company's customers. The Company's research and
development efforts are currently focused primarily on adding functionality to
the Company's OneServer application and developing new implementations of
OneServer for selected vertical markets. The Company's research and
development staff consisted of 45 employees as of December 31, 1996. In the
future, the Company intends to continue to increase its development staff. The
level of research and development costs will vary, however, depending upon the
amount of development work being performed by the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The Company's success will depend upon its ability to develop new products
and provide new services that meet changing customer requirements. The market
for the Company's products is characterized by rapidly changing technology,
evolving industry standards and customer requirements, emerging competition
and frequent new product and service introductions. As a result, the Company
may be required to change and improve its products in response to changes in
operating systems, application and networking software, computer and
communications hardware, programming tools and computer language technology.
There can be no assurance that the Company can successfully respond to
changing technology, identify new product opportunities or develop and bring
new products and services to market in a timely manner. Failure of the
Company, for technological or other reasons, to develop and introduce new
products and product enhancements and new services that are compatible with
industry standards and that satisfy customer requirements would have a
material adverse effect on the Company's business, operating results and
financial condition. See "Risk Factors--Dependence upon Product Development;
Risks of Technological Change and Evolving Industry Standards."
COMPETITION
The market for interactive commerce software is new, rapidly evolving and
intensely competitive. The Company expects competition to intensify in the
future.
The Company competes with vendors of prepackaged electronic commerce
software, vendors of software tools for developing electronic commerce
applications, system integrators and providers of business application
software. In addition, potential customers may elect to develop their own
interactive commerce solutions. The Company's competitors include OMI and
BroadVision. The Company expects additional competition from other emerging
and established companies, including Microsoft, IBM/Lotus, Oracle,
Informix/Illustra, Interworld, and Actra ( a joint venture of Netscape and
GEIS) all of which have announced or released products for Internet-based
electronic commerce. The Company's potential competitors also include a number
of successful client/server applications software companies, such as Baan,
PeopleSoft, Vantive and SAP, and EDI solution vendors, including Sterling
Commerce and GEIS.
Many of these competitors have longer operating histories and significantly
greater financial, technical, marketing and other resources than the Company
and thus may be able to respond more quickly to new or changing opportunities,
technologies and customer requirements. Also, many current and potential
competitors have greater name recognition and more extensive customer bases
that could be leveraged, thereby gaining market share to the Company's
detriment. Such competitors may be able to undertake more extensive
promotional activities, adopt more aggressive pricing policies and offer more
attractive terms to purchasers than the Company and to bundle their products
in a manner that may discourage users from purchasing products offered by the
Company. In addition, current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties
to enhance their products. Accordingly, it is possible that new competitors or
alliances among competitors may emerge and rapidly acquire significant market
share. There can be no assurance that the Company will be able to compete
effectively with competitors or that the competitive pressures faced by the
Company will not have a material adverse effect on the Company's business,
operating results and financial condition.
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The Company believes that rapid implementation of software applications is
critical to success in the Internet-based interactive commerce applications
market. The Company has a limited history in implementing its products and
there can be no assurance that the Company will be able to meet customer needs
and expectations in this regard. Additional competitive factors affecting the
market for the Company's services and software products include vendor and
product reputation, architecture, functionality and features, ease of use,
time-to-market, quality of support, product quality, performance and price. In
order to be successful in the future, the Company must continue to respond
promptly and effectively to the challenges of technical change and
competitors' innovations. Performance in these areas will, in turn, depend
upon the Company's ability to attract and retain highly qualified technical
and sales personnel in a competitive market for experienced and talented
software developers, sales representatives and managers.
PROPRIETARY RIGHTS
The Company relies on trademark, copyright and trade secret laws, employee
and third-party non-disclosure agreements and other methods to protect its
proprietary rights. The Company does not currently have any patents or pending
patent applications. The Company believes that, due to the rapid pace of
technological innovation for Internet products, the Company's ability to
establish and maintain a position of technology leadership in the industry
depends more on the skills of its development personnel, new product
developments, frequent product enhancements, and name recognition than upon
the legal protections afforded its existing technology. The Company seeks to
protect its software, documentation and other written materials under trade
secret and copyright laws, which afford only limited protection. Despite the
Company's efforts to protect its proprietary rights, unauthorized parties may
attempt to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Policing unauthorized use
of the Company's products is difficult, and while the Company is unable to
determine the extent to which piracy of its software products exists, software
piracy can be expected to be a persistent problem. In addition, the laws of
some foreign countries do not protect the Company's proprietary rights as
fully as do the laws of the United States. There can be no assurance that the
Company's means of protecting its proprietary rights in the United States or
abroad will be adequate. There can be no assurance that its agreements with
employees, consultants and others who participate in the development of its
software will not be breached, that the Company will have adequate remedies
for any breach, or that the Company's trade secrets will not otherwise become
known to or independently developed by competitors. Furthermore, there can be
no assurance that the Company's efforts to protect its rights through
trademark and copyright laws will not fail to prevent the development and
design by others of products or technology similar to or competitive with
those developed by the Company.
The Company expects that software product developers will increasingly be
subject to infringement claims as the number of products and competitors in
the Company's industry segment grows and the functionality of products in
different industry segments overlaps and there can be no assurance that third
parties will not assert infringement claims against the Company. Any such
claims, with or without merit, could be time consuming to defend, result in
costly litigation, divert management's attention and resources, cause product
shipment delays or require the Company to enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to the Company, if at all. In the event of a
successful claim of product infringement against the Company and failure or
inability of the Company to license the infringed or similar technology, the
Company's business, operating results and financial condition would be
materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of Operations."
EMPLOYEES
At December 31, 1996, CONNECT employed 149 people full time, of whom 43 were
involved in sales and marketing, 48 were involved in services, 45 were
involved in research and development and 13 were involved in finance and
administration. The Company has not experienced any work stoppages and
considers its employee relations to be good.
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RISK FACTORS
RECENT INTRODUCTION OF PRIMARY PRODUCTS; PRODUCT CONCENTRATION
Although the Company was founded in 1987, it recently initiated a new
business strategy focused on providing packaged software applications for
Internet-based interactive commerce. Consequently, the Company is decreasing
its reliance on historical sources of revenue and its current and future
business prospects are dependent upon the successful development, market
acceptance and sales of OneServer, released in September 1995, and
OrderStream, released in June 1996. Accordingly, the Company's business must
be considered in light of the risks, expenses and problems frequently
encountered by companies in an early stage of development, particularly
companies in new and rapidly evolving markets such as the Internet. Such risks
include a lack of acceptance of products and services by target customers, the
development of equal or superior products or services by competitors, the
failure of electronic commerce in general, and Internet-based electronic
commerce in particular, to be broadly adopted, the inability of the Company to
develop and enhance competitive products or to successfully commercialize any
such products, and the inability of the Company to identify, attract, retain
and motivate qualified personnel. There can be no assurance that the Company
will succeed in addressing such risks.
As of December 31, 1996, CONNECT had licensed OneServer or OrderStream to
over 20 customers. The Company expects OneServer, OrderStream and related
services to account for most of its revenues for the foreseeable future. As a
result, factors adversely affecting the pricing of, or demand for OneServer,
and OrderStream, such as competition, technological change, failure of the
market for Internet-based packaged applications to develop as the Company
anticipates, lack of customer acceptance of OneServer and OrderStream, or
failure of the Company to develop and introduce new and enhanced versions of
OneServer and OrderStream on a timely basis, could have a material adverse
effect on its business, operating results and financial condition. Further, if
any of the Company's customers are not able to successfully develop and deploy
interactive commerce applications with OneServer or OrderStream or for any
other reason are not satisfied with its products or services, the Company's
reputation could be damaged, which could have a material adverse effect on its
business, operating results and financial condition.
ACCUMULATED DEFICIT AND ANTICIPATED FUTURE LOSSES
The Company has not realized a profit in any year, and as of December 31,
1996 had an accumulated deficit of approximately $47.0 million. In 1996 and
1995, the Company experienced significant negative cash flow from operations.
The Company's operating expenses and net losses increased substantially in
1996 and in 1995 compared to prior periods primarily as a result of increased
research and development expenses relating to the development of OrderStream
and Version 1.2 of OneServer and increased sales and marketing expenses
attributable to the building of a direct sales force and development of a
position in the emerging Internet-based packaged application software market.
The Company anticipates that operating expenses will continue to increase
significantly, resulting in continuing net losses and negative cash flow from
operations for the foreseeable future. There can be no assurance that the
Company can generate revenue growth, or that any revenue growth that is
achieved can be sustained. To the extent that increases in such operating
expenses precede or are not subsequently followed by increased revenues, the
Company's business, results of operations and financial condition would be
materially adversely affected. There can be no assurance that the Company will
ever achieve or sustain profitability. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company has experienced and expects to continue to experience
significant fluctuations in quarterly operating results that may be caused by
many factors including, among others, the number, timing and significance of
product enhancements and new product announcements by the Company or its
competitors, the ability of the Company to develop, introduce and market new
and enhanced versions of the Company's products
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on a timely basis, the length of the Company's sales cycle, market acceptance
of and demand for the Company's products, the pace of development of
electronic commerce conducted on the Internet, the mix of the Company's
products sold, customer order deferrals in anticipation of enhancements or new
products offered by the Company or its competitors, nonrenewal of service
agreements, software defects and other product quality problems, the Company's
ability to attract and retain key personnel, the extent of international
sales, changes in the level of operating expenses and general economic
conditions. The Company anticipates that a significant portion of its revenue
will be derived from a limited number of orders placed by large corporations,
and the timing of receipt and fulfillment of any such orders is expected to
cause material fluctuations in the Company's operating results, particularly
on a quarterly basis. The Company expects to recognize the majority of its
license revenue in the last month of each quarter. As a result, any delay in
delivery of products at the end of a quarter could materially adversely affect
operating results for that quarter. In addition, the Company intends, in the
near term, to significantly increase its personnel, including its direct sales
force and development team. The timing of such expansion and the rate at which
new sales people become productive could also cause material fluctuations in
the Company's quarterly operating results. Furthermore, the operating results
of many software companies reflect seasonal trends, and the Company expects to
be affected by such trends in the future.
Due to the foregoing factors, quarterly revenue and operating results are
difficult to forecast. In addition, as a result of the Company's recent shift
in business strategy, the Company's results of operations should not be relied
upon as indicative of future results. Revenue is also difficult to forecast
because the market for Internet-based packaged applications software is
rapidly evolving and the Company's sales cycle may vary substantially from
customer to customer. Further, the Company's expense levels are based, in
significant part, on the Company's expectations as to future revenue and are
therefore relatively fixed in the short term. If revenue levels fall below
expectations, net income is likely to be disproportionately adversely affected
because a proportionately smaller amount of the Company's expenses varies with
its revenue. There can be no assurance that the Company will be able to
achieve or maintain profitability on a quarterly or annual basis in the
future. Due to all the foregoing factors, in some future quarter the Company's
operating results may be below the expectations of securities analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
DEPENDENCE UPON PRODUCT DEVELOPMENT; RISKS OF TECHNOLOGICAL CHANGE AND
EVOLVING INDUSTRY STANDARDS
The Company's success will depend upon its ability to develop new products
and provide new services that meet changing customer requirements. The market
for the Company's products is characterized by rapidly changing technology,
evolving industry standards and customer requirements, emerging competition
and frequent new product and service introductions. As a result, the Company
may be required to change and improve its products in response to changes in
operating systems, application and networking software, computer and
communications hardware, programming tools and computer language technology.
In particular, the Company's software operates on the HP-UX 10 and Sun Solaris
2.4/2.5 versions of the UNIX operating system. The Company plans to port its
software to the Windows NT operating system from Microsoft Corporation
("Microsoft") in the future due to increasing adoption of Windows NT by the
Company's potential customers. The Company has not begun the development work
necessary to port its software to Windows NT. There can be no assurance that
the Company will be successful in developing and marketing, on a timely basis,
products ported to the Windows NT operating system or any other operating
system. As a result, any shift in the market toward products running on
operating systems other than UNIX, including Windows NT, before the Company
offers versions of its software running on such operating systems, could have
a material adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that the Company can
successfully respond to changing technology, identify new product
opportunities or develop and bring new products and services to market in a
timely manner. The Company has in the past experienced delays in software
development and there can be no assurance that the Company will not experience
delays in connection with its current or future product development
activities. Delays and difficulties associated with new product introductions
or product enhancements could have a material adverse effect on the Company's
business,
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operating results and financial condition. Failure of the Company, for
technological or other reasons, to develop and introduce new products and
product enhancements and new services on a timely basis that are compatible
with industry standards and that satisfy customer requirements would have a
material adverse effect on the Company's business, operating results and
financial condition.
In addition, the Company or its competitors may announce enhancements to
existing products or services, or new products or services embodying new
technologies, industry standards or customer requirements that have the
potential to supplant or provide lower cost alternatives to the Company's
existing products and services. The introduction of such enhancements or new
products and services could render the Company's existing products and
services obsolete and unmarketable. There can be no assurance that the
announcement or introduction of new products or services by the Company or its
competitors or any change in industry standards will not cause customers to
defer or cancel purchases of existing products or services, which could have a
material adverse effect on the Company's business, operating results and
financial condition.
Furthermore, introduction by the Company of products or services with
reliability, quality or compatibility problems could result in reduced orders,
delays in collecting accounts receivable and additional service costs. The
failure to introduce a new product, service or product enhancement on a timely
basis could delay or hinder market acceptance. Any such event could have a
material adverse effect on the Company's business, operating results and
financial condition. See "Business--Products and Services."
COMPETITION
The market for interactive commerce software is new, rapidly evolving and
intensely competitive. The Company expects competition to intensify in the
future.
The Company competes with vendors of prepackaged electronic commerce
software, vendors of software tools for developing electronic commerce
applications, system integrators and providers of business application
software. In addition, potential customers may elect to develop their own
interactive commerce solutions. The Company's competitors include Open Market,
Inc. ("OMI") and BroadVision, Inc. ("BroadVision"). The Company expects
additional competition from other emerging and established companies,
including Microsoft, IBM/Lotus, Oracle Corporation ("Oracle"),
Informix/Illustra, Interworld and Actra, all of which have announced products
for Internet-based electronic commerce. In addition, in June 1996 Microsoft
announced that it had acquired eShop Inc., a provider of software programming
tools for creating electronic commerce applications. The Company's potential
competitors also include a number of successful client/server applications
software companies, such as Baan Company ("Baan"), PeopleSoft, Inc.
("PeopleSoft"), Vantive Corporation ("Vantive") and SAP AG ("SAP"), and
electronic data interchange (EDI) solution vendors, including Sterling
Commerce, Inc. ("Sterling Commerce") and General Electric Information Services
Corporation ("GEIS").
Many of these competitors have longer operating histories and significantly
greater financial, technical, marketing and other resources than the Company
and thus may be able to respond more quickly to new or changing opportunities,
technologies and customer requirements. Also, many current and potential
competitors have greater name recognition and more extensive customer bases
that could be leveraged, thereby gaining market share to the Company's
detriment. Such competitors may be able to undertake more extensive
promotional activities, adopt more aggressive pricing policies and offer more
attractive terms to purchasers than the Company and to bundle their products
in a manner that may discourage users from purchasing products offered by the
Company. In addition, current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties
to enhance their products. Accordingly, it is possible that new competitors or
alliances among competitors may emerge and rapidly acquire significant market
share. There can be no assurance that the Company will be able to compete
effectively with competitors or that the competitive pressures faced by the
Company will not have a material adverse effect on the Company's business,
operating results and financial condition. See "Business--Competition."
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MANAGEMENT OF RAPIDLY CHANGING BUSINESS; NEW MANAGEMENT TEAM; DEPENDENCE ON
KEY PERSONNEL
The Company's anticipated expansion of operations will place a significant
strain on the Company's managerial, operational and financial resources. To
manage this anticipated expansion, the Company must continue to implement and
improve its operational and financial controls and systems and to expand,
train and manage its employee base. Further, the Company will need to manage
multiple relationships with various customers and other third parties. There
can be no assurance that the Company will be able to implement on a timely
basis the systems, procedures or controls required to support its operations
or that will enable the Company to successfully market its products and
services. The Company's future operating results will also depend on its
ability to expand its sales and marketing organization, establish a
distribution channel to penetrate different and broader markets and expand its
support organization. If the Company is unable to respond effectively to
changing business conditions, its business, operating results and financial
condition would be materially adversely affected.
The Company's performance depends substantially on the performance of its
executive officers and key employees, many of whom have joined the Company in
the last 18 months. Specifically, Patrick D. Quirk, Vice President of Sales,
Gordon J. Bridge, Chairman, Craig D. Norris, Vice President of Professional
Services, Barton S. Foster, Vice President of Marketing, Joseph G. Girata,
Vice President of Finance and Administration and Chief Financial Officer, and
Victor Fischer, Chief Information Officer and Vice President of Operations
joined the Company in July 1995, November 1995, January 1996, March 1996, June
1996 and October 1996, respectively. These individuals have not previously
worked together and there can be no assurance that they can successfully
integrate as a management team. The Company's future success also depends on
its continuing ability to identify, hire, train and retain other highly
qualified technical and managerial personnel. Competition for such personnel
is intense, and there can be no assurance that the Company will be able to
attract, assimilate or retain other highly qualified technical and managerial
personnel in the future. The inability to attract and retain its executive
officers and other key technical and managerial personnel could have a
material adverse effect upon the Company's business, operating results and
financial condition. See "Business--Customers" and "--Employees".
UNCERTAIN ACCEPTANCE OF THE INTERNET AS A MEDIUM FOR ELECTRONIC COMMERCE
The market for Internet-based packaged software applications, including
electronic commerce applications, was less than $1.0 million in 1995,
according to Forrester Research, Inc. ("Forrester Research"). The Company's
future operating results depend upon the development and growth of this new
and rapidly evolving market, which itself is dependent upon acceptance of
electronic commerce and the Internet as an effective sales, marketing and
order capture medium. The acceptance of electronic commerce in general and, in
particular, the Internet as a sales, marketing and order capture medium are
highly uncertain and subject to a number of risks. Critical issues concerning
the commercial use of the Internet (including security, reliability, cost,
ease of use, quality of service and the effect of government regulation)
remain unresolved and may impact the growth of the Internet. If widespread use
of the Internet for commercial transactions does not develop or if the
Internet does not develop as an effective sales, marketing and order capture
medium, the Company's business, operating results and financial condition
would be materially adversely affected.
The adoption of the Internet for sales, marketing, order capture and other
commercial transactions, and the development of a market for packaged
electronic commerce applications require acceptance of new ways of transacting
business and exchanging information. In particular, enterprises that have
already invested substantial resources in other means of transacting business
may be particularly reluctant to adopt a new strategy that may make certain of
their existing personnel and infrastructure obsolete. If the market for
Internet-based packaged applications fails to develop or develops more slowly
than the Company anticipates, or if the Company's products do not achieve
market acceptance, the Company's business, operating results and financial
condition would be materially adversely affected.
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RISKS ASSOCIATED WITH COMPLEX SOFTWARE PRODUCTS; LENGTHY SALES AND
IMPLEMENTATION CYCLES
The Company's products are complex and expensive and will generally involve
significant investment decisions by prospective customers. Accordingly, the
license of the Company's software products is often an executive-level
decision by prospective customers and can be expected to require the Company
to engage in a lengthy sales cycle to provide a significant level of education
to prospective customers regarding the use and benefits of the Company's
products. In addition, the implementation of the Company's products involves a
significant commitment of resources by customers over an extended period of
time. As a result, the Company's sales and customer implementation cycles are
subject to a number of significant delays over which it has little or no
control. The Company has limited experience with implementing its
applications, and most of the Company's OneServer and OrderStream customers
are at an early stage in the process of implementing the application and
rolling it out for commercial use. The Company believes that rapid
implementation is critical to success in the Internet-based interactive
commerce applications market. Significant delays in implementation, whether or
not such delays are within the Company's control, could materially adversely
affect its business, operating results and financial condition. From time to
time, the Company enters into fixed price arrangements for its implementation
services and currently has three such arrangements. Fixed price arrangements
have resulted in the past, and could in the future result in, losses primarily
due to delays in the implementation process or other complexities associated
with completion of the project. Such losses have had a material adverse effect
on the Company's business, operating results and financial condition. In
addition, delays in license transactions due to lengthy sales cycles or delays
in customer production or deployment of a system could have a material adverse
effect on the Company's business, operating results and financial condition
and could be expected to cause the Company's operating results to vary
significantly from quarter to quarter. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business--
Marketing and Sales."
The marketability and acceptance of OneServer and OrderStream also will be
highly dependent on the success of initial implementations of these products
by the Company's customers. Problems or delays experienced by the Company's
initial customers in the installation and use of OneServer or OrderStream,
even if such problems or delays are not attributable to the Company or its
products, or a failure of the Company's customers to successfully attract
purchasers to interactive commerce Web sites, could slow the rate of adoption
of the Company's products by other potential customers. Moreover, products as
complex as those offered by the Company may contain undetected errors when
first introduced or when new versions are released. There can be no assurance
that, despite testing by the Company, errors will not occur in current or new
products after commencement of commercial shipments, resulting in adverse
publicity, in loss of or delay in market acceptance, or in claims by the
customer against the Company, which would have a material adverse effect on
the Company's business, operating results and financial condition.
DEPENDENCE UPON SERVICE PROVIDERS
The Company expects that its customers will typically rely on professional
services organizations, such as consulting firms and systems integrators, as
well as design firms to assist with implementation of the Company's products.
If the Company is unable to adequately train a sufficient number of such firms
or if for any reason a large number of such firms support or promote competing
products or technologies, the Company's business, operating results and
financial condition could be materially adversely affected. Many of these
relationships are not subject to formal agreements and none of such providers
are under any obligation to provide services to the Company or its customers.
Failure of the Company to develop and maintain relationships with leading
service providers and design firms could adversely impact the Company's
ability to successfully market, sell and deploy its products, which would have
a material adverse effect on the Company's business, operating results and
financial condition. See "Business--Marketing and Sales," "--Solution
Partners," "--Competition" and "--Proprietary Rights."
DEPENDENCE UPON CERTAIN LICENSES
The Company relies on certain technology that it licenses from third
parties, including a relational database management system from Oracle, a text
search engine from Fulcrum Technologies Inc. ("Fulcrum"), encryption
technology from RSA Data Security, Inc. ("RSA") and other software that is
integrated with internally
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developed software and used in the Company's software to perform key
functions. Oracle also offers products that are competitive with those offered
by the Company. There can be no assurance that the Company's third-party
technology licenses will continue to be available to the Company on
commercially reasonable terms, or at all. The loss or inability to maintain
any of these technology licenses could result in delays in introduction of the
Company's products and services until equivalent technology, if available, is
identified, licensed and integrated, which could have a material adverse
effect on the Company's business, operating results and financial condition.
See "Business--Solution Partners" and "--Proprietary Rights."
DEPENDENCE UPON THE INTERNET INFRASTRUCTURE
The use of the Company's products and services will depend in large part
upon the continued development of the infrastructure for providing Internet
access and services. Because global commerce and online exchange of
information on the Internet is new and evolving, it is difficult to predict
with any assurance whether the Internet will prove to be a viable commercial
marketplace. The Internet has experienced, and is expected to continue to
experience, substantial growth in the number of users and amount of traffic.
There can be no assurance that the Internet infrastructure will continue to be
able to support the demands placed on it by this continued growth. In
addition, the Internet could lose its viability due to delays in the
development or adoption of new standards and protocols to handle increased
levels of Internet activity, or due to increased governmental regulation.
Further, the costs of use of the Internet could increase to a degree which
reduces its attraction as a platform for electronic commerce. As a result,
there can be no assurance that the infrastructure or complementary services
necessary to make the Internet a viable commercial marketplace will be
developed, or, if developed, that the Internet will become a viable commercial
marketplace for products and services such as those offered by the Company. If
the necessary infrastructure or complementary services or facilities are not
developed, or if the Internet does not become a viable commercial marketplace,
the Company's business, operating results and financial condition would be
materially adversely affected.
RISKS ASSOCIATED WITH EXPANDING DISTRIBUTION
To date, the Company has sold its products through a direct sales force. The
Company's ability to achieve revenue growth in the future will depend in large
part upon its success in recruiting and training sufficient direct sales
personnel and establishing and maintaining relationships with distributors,
resellers, systems integrators and other third parties. Although the Company
is currently investing, and plans to continue investing, significant resources
to expand its sales force and to develop distribution relationships with
third-party distributors and resellers, the Company may at times experience
difficulty in recruiting qualified sales personnel and in establishing
necessary third-party alliances. In addition, as the Company hires new sales
personnel it is anticipated that there will be a delay before such personnel
become productive. There can be no assurance that the Company will be able to
successfully expand its direct sales force or other distribution channels or
that any such expansion will result in an increase in revenues. Any failure by
the Company to expand its direct sales force or other distribution channels
would materially adversely affect the Company's business, operating results
and financial condition. See "Business--CONNECT Strategy" and "--Marketing and
Sales."
RISKS ASSOCIATED WITH SECURITY, SYSTEM DISRUPTIONS AND COMPUTER INFRASTRUCTURE
Despite the implementation in the Company's products of various security
mechanisms, the Company's products may be vulnerable to break-ins and similar
disruptive problems caused by Internet users. The level of security provided
by the Company's products is dependent upon the level of security selected by
the Company's customers and the proper configuration and use of the products'
security mechanisms. Such computer break-ins and other disruptions would
jeopardize the security of information stored in and transmitted through the
computer systems of users of the Company's products, which may result in
significant liability to the Company and may also deter potential customers.
Persistent security problems continue to plague public and private data
networks. Recent break-ins reported in the press and otherwise have included
incidents involving hackers bypassing firewalls by posing as authorized
computers and involving the theft of confidential information. Alleviating
problems caused by third parties may require significant expenditures of
capital and resources by the Company. Such expenditures could have a material
adverse effect on the Company's business, operating results and
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financial condition. Moreover, the security and privacy concerns of existing
and potential customers, as well as concerns related to computer viruses, may
inhibit the growth of the Internet marketplace generally, and the Company's
customer base and revenues in particular. There can be no assurance that the
Company's attempts to limit its liability to customers, including liability
arising from a failure of the security feature contained in the Company's
products, through contractual provisions will be enforceable. The Company
currently does not have product liability insurance to protect against these
risks and there can be no assurance that such insurance will be available to
the Company on commercially reasonable terms, or at all.
As part of the Company's services, the Company operates and manages online
networks for certain of its customers on a seven day per week, 24-hour basis,
and provides hosting for certain customers' OneServer/Orderstream
applications. These services depend upon the Company's ability to protect the
computer equipment and the information stored in its data center against
damage that may be caused by fire, earthquakes, power loss, telecommunications
failures, unauthorized entry and other similar events. Any such damage or
failure that causes interruptions in the Company's operations could materially
adversely affect the businesses of the Company's customers, which could expose
the Company to liability for these adverse effects.
DEPENDENCE UPON PROPRIETARY RIGHTS; RISKS OF INFRINGEMENT
The Company relies on trademark, copyright and trade secret laws, employee
and third-party non-disclosure agreements and other methods to protect its
proprietary rights. The Company does not currently have any patents or pending
patent applications. The Company believes that, due to the rapid pace of
technological innovation for Internet products, the Company's ability to
establish and maintain a position of technology leadership in the industry
depends more on the skills of its development personnel, new product
developments, frequent product enhancements, and name recognition than upon
the legal protections afforded its existing technology. The Company seeks to
protect its software, documentation and other written materials under trade
secret and copyright laws, which afford only limited protection. Despite the
Company's efforts to protect its proprietary rights, unauthorized parties may
attempt to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Policing unauthorized use
of the Company's products is difficult, and while the Company is unable to
determine the extent to which piracy of its software products exists, software
piracy can be expected to be a persistent problem. In addition, the laws of
some foreign countries do not protect the Company's proprietary rights as
fully as do the laws of the United States. There can be no assurance that the
Company's means of protecting its proprietary rights in the United States or
abroad will be adequate. There can be no assurance that its agreements with
employees, consultants and others who participate in the development of its
software will not be breached, that the Company will have adequate remedies
for any breach, or that the Company's trade secrets will not otherwise become
known to or independently developed by competitors. Furthermore, there can be
no assurance that the Company's efforts to protect its rights through
trademark and copyright laws will not fail to prevent the development and
design by others of products or technology similar to or competitive with
those developed by the Company.
The Company expects that software product developers will increasingly be
subject to infringement claims as the number of products and competitors in
the Company's industry segment grows and the functionality of products in
different industry segments overlaps and there can be no assurance that third
parties will not assert infringement claims against the Company. Any such
claims, with or without merit, could be time consuming to defend, result in
costly litigation, divert management's attention and resources, cause product
shipment delays or require the Company to enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to the Company, if at all. In the event of a
successful claim of product infringement against the Company and failure or
inability of the Company to license the infringed or similar technology, the
Company's business, operating results and financial condition would be
materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
On March 25, 1996, PhotoDisc, Inc. ("PhotoDisc"), one of the Company's
licensees of OneServer, was sued, along with 21 other defendants including
AGFA Division-Miles Inc. ("AGFA"), Axcis Information Network, Inc. ("Axcis"),
Software Publishing Corporation ("SPC"), and others, in the Federal District
Court
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in Connecticut, by E-data Corporation ("E-data"). In the litigation against
PhotoDisc, E-data alleges that PhotoDisc is infringing E-data's U.S. Patent
No. 4,528,643 issued July 9, 1985, entitled "System for Reproducing
Information in Material Objects at Point of Sale Location," in connection with
electronic distribution of images on the Internet. E-data has also sued other
defendants including Broderbund Software, Inc. ("Broderbund"), CompuServe Inc.
("CompuServe"), Adobe Systems Incorporated ("Adobe") and others in the Federal
District Court in New York City alleging infringement of the same patent.
PhotoDisc tendered the defense of its E-data litigation to the Company.
Based upon the Company's review of the E-data patent and the nature of the
claims and the Company's indemnity obligations, and after consultation with
counsel, management believes that the resolution of this matter will not have
a material adverse effect on the Company's business, operating results and
financial condition. However, given the early stage of the litigation and the
complex technical issues and uncertainties in patent litigation, the results
of these proceedings, including any potential settlement, are uncertain and
there can be no assurance that E-data will not prevail in the current
litigation or that it will not bring similar claims against other licensees of
the Company. If E-data were to prevail, PhotoDisc could be required to pay
damages to E-data for the infringement of its patent and enter into a
licensing or royalty arrangement in order to continue to conduct its online
business in the same manner. There can be no assurance that the amount of such
damages would not be material or that such license or royalty arrangement
would be available on acceptable terms. Under the terms of its license with
PhotoDisc, the Company may be required to defend against the E-data claim and
to indemnify PhotoDisc for some or all of its losses in connection with the
litigation, any settlement or judgment and any ongoing license fees or
royalties. In addition, whether or not the Company were to prevail in any
defense of PhotoDisc, such litigation could be time consuming and costly to
defend.
POSSIBLE VOLATILITY OF STOCK PRICE
The market price of the Common Stock could be subject to significant
fluctuations in response to quarter-to-quarter variations in the Company's
operating results, announcements of technological innovations or new products
and services by the Company or its competitors, and other events or factors.
For example, any shortfall in revenue or net income, or increase in losses or
expenses from levels expected by securities analysts, could have an immediate
and significant adverse effect on the market price of the Company's Common
Stock. In addition, the stock market in recent years, and in particular the
market for stocks relating to the Internet, has experienced extreme price and
volume fluctuations that have particularly affected the market prices of many
high technology companies and that have often been unrelated or
disproportionate to the operating performance of companies. These
fluctuations, as well as general economic and market conditions, may adversely
affect the market price for the Common Stock.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES
The Company is not currently subject to direct regulation by any government
agency, other than regulations applicable to businesses generally, and there
are currently few laws or regulations directly applicable to access to, or
commerce on, the Internet. However, due to the increasing popularity and use
of the Internet, it is possible that a number of laws and regulations may be
adopted with respect to the Internet, covering issues such as user privacy,
pricing and characteristics and quality of products and services. The
Telecommunications Reform Act of 1996 imposes criminal penalties on anyone who
distributes obscene, lascivious or indecent communications on the Internet.
The adoption of any such laws or regulations may decrease the growth of the
Internet, which could in turn adversely affect the Company's business,
operating results or financial condition. Moreover, the applicability to the
Internet of existing laws governing issues such as property ownership, libel
and personal privacy is uncertain. Further, due to the encryption technology
contained in the Company's products, such products are subject to U.S. export
controls. There can be no assurance that such export controls, either in their
current form or as may be subsequently enacted, will not delay the
introduction of new products or limit the Company's ability to distribute
products outside of the United States or electronically. While the Company
intends to take precautions against unlawful exportation, the global nature of
the Internet makes it difficult to effectively control the distribution of the
Company's products. In addition, federal or state legislation or
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regulation may further limit levels of encryption or authentication
technology. Further, various countries regulate the import of certain
encryption technology and have adopted laws relating to personal privacy
issues which could limit the Company's ability to distribute products in those
countries. Any such export or import restrictions, new legislation or
regulation or government enforcement of existing regulations could have a
material adverse impact on the Company's business, operating results and
financial condition.
CONTROL BY EXISTING SECURITY HOLDERS
As of December 31, 1996, the Company's officers and directors, together with
entities affiliated with them, own approximately 60.5% of the outstanding
Common Stock of the Company. Such persons will have sufficient power to
control the outcome of many matters (including the election of directors, and
any merger, consolidation or sale of all or substantially all of the Company's
assets) submitted to the stockholders for approval. As a result, certain
transactions will not be possible without the approval of these stockholders.
These transactions include proxy contests, mergers involving the Company,
tender offers, open-market purchase programs or other purchases of Common
Stock that could give stockholders of the Company the opportunity to realize a
premium over the then-prevailing market price for their shares of Common
Stock.
ANTITAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS
The Board of Directors has the authority to issue up to 10,000,000 shares of
Preferred Stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote or action by the stockholders. The rights of the holders of Common Stock
will be subject to, and may be adversely affected by, the rights of the
holders of any Preferred Stock that may be issued in the future. The issuance
of Preferred Stock may have the effect of delaying, deferring or preventing a
change of control of the Company without further action by the stockholders
and may adversely affect the voting and other rights of the holders of Common
Stock. The Company has no present plans to issue shares of Preferred Stock.
Further, certain provisions of the Company's charter documents, including
provisions eliminating the ability of stockholders to take action by written
consent and limiting the ability of stockholders to raise matters at a meeting
of stockholders without giving advance notice, may have the effect of delaying
or preventing changes in control or management of the Company, which could
have an adverse effect on the market price of the Company's Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of the Company's Common Stock in the public
market or the anticipation of such sales could materially affect then
prevailing market prices. The effect of such sales may be exacerbated further
by the relatively low trading volume of the Company's Common Stock. The
Securities and Exchange Commission has recently adopted changes to Rule 144
under the Securities Act of 1933, as amended (the "Securities Act"), which
changes will become effective on April 29, 1997. As a result of such changes,
substantially all of the unregistered shares of the Company's Common Stock
which are not already eligible for resale under Rule 144 or Rule 701 under the
Securities Act will become eligible for resale pursuant to Rule 144 on such
date, subject in some cases to volume limitations and other requirements
ITEM 2. PROPERTIES
FACILITIES
The Company is headquartered in Mountain View, California, where it leases
an aggregate of approximately 30,000 square feet of space which houses
administrative, sales and marketing, customer service and product development
activities. The Company's field operations occupy leased facilities in
Oakbrook Terrace, Illinois, Stamford, Connecticut, Dallas, Texas, and London,
England. The Company believes that its existing facilities are adequate to
meet current needs, but may need to lease additional space in late 1997. There
can be no assurance additional space will be available on reasonable terms.
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ITEM 3.
LEGAL PROCEEDINGS
On March 25, 1996, PhotoDisc, one of the Company's licensees of OneServer,
was sued, along with 21 other defendants including AGFA, Axcis, SPC and
others, in the Federal District Court in Connecticut, by E-data. In the
litigation against PhotoDisc, E-data alleges that PhotoDisc is infringing E-
data's U.S. Patent No. 4,528,643 issued July 9, 1985, entitled "System for
Reproducing Information in Material Objects at Point of Sale Location," in
connection with electronic distribution of images on the Internet. E-data has
also sued other defendants including Broderbund, CompuServe, Adobe and others
in the Federal District Court in New York City. PhotoDisc tendered the defense
of its E-data litigation to the Company.
Based upon the Company's review of the E-data patent and the nature of the
claims and the Company's indemnity obligations, and after consultation with
counsel, management believes that the resolution of this matter will not have
a material adverse effect on the Company's business, operating results and
financial condition. However, given the early stage of the litigation and the
complex technical issues and uncertainties in patent litigation, the results
of these proceedings, including any potential settlement, are uncertain and
there can be no assurance that E-data will not prevail in the current
litigation or that it will not bring similar claims against other licensees of
the Company. If E-data were to prevail, PhotoDisc could be required to pay
damages to E-data for the infringement of its patent and enter into a
licensing or royalty arrangement in order to continue to conduct its business
in the same manner. There can be no assurance that the amount of such damages
would not be material or that such license or royalty arrangement would be
available on acceptable terms. Under the terms of its license with PhotoDisc,
the Company may be required to defend against the E-data claim and to
indemnify PhotoDisc for some or all of its losses in connection with the
litigation, any settlement or judgement and any ongoing license or royalty
fees. In addition, whether or not the Company were to prevail in any defense
of PhotoDisc, such litigation could be time consuming and costly to defend.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal year ended December 31, 1996.
ITEM 5. MARKET FOR THE COMPANY'S EQUITY AND RELATED STOCKHOLDER MATTERS
COMMON STOCK MARKET PRICES AND DIVIDENDS
The Company's common stock is traded on the National Association of
Securities Dealers Automated Quote system (NASDAQ). The Company's Nasdaq
National Market symbol is "CNKT". The number of record holders of the
Company's common stock as of December 31, 1996 was 186.
High and low stock prices and dividends since the commencement of its
initial public offering on August 15, 1996 were:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
----------------------------------------
CASH
DIVIDENDS
SALE PRICE DECLARED
----------------------- -------------
QUARTER ENDED HIGH LOW
------------- --------- ---------
<S> <C> <C> <C>
August 15, to September 30....... $ 6 3/4 $ 5 1/8 None
December 31...................... $ 10 $ 5 1/4 None
</TABLE>
The Company expects to continue its current policy of not paying cash
dividends for the foreseeable future.
17
<PAGE>
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is U.S. Stock Transfer
Corporation. Its telephone number is (800) 835-8778.
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
License........................ $ 4,693 $ 288 $ 1,627 $ 1,015 $ 212
Service........................ 5,487 8,285 6,345 2,847 2,617
-------- -------- ------- ------- -------
Total revenue................. 10,180 8,573 7,972 3,862 2,829
Loss from operations(1)......... (16,358) (13,194) (1,540) (1,648) (2,691)
Net loss(1)..................... $(16,142) $(14,139) $(1,765) $(1,921) $(2,932)
Pro forma net loss per share(2). $ (0.90) $ (0.79)
Shares used in computing pro
forma net loss per share(2).... 17,911 17,814
BALANCE SHEET DATA:
Cash and cash equivalents....... $ 12,214 $ 12,929 $ 1,594 $ 64 $ 142
Working capital (deficit)....... $ 10,344 $ 11,302 $(2,786) $(1,045) $(2,814)
Total assets.................... $ 19,154 $ 18,063 $ 5,161 $ 1,743 $ 814
Long-term debt.................. $ 790 $ 1,636 $ 1,167 $ 1,570 $ 1,125
Stockholders' equity (deficit).. $ 13,355 $ 13,318 $(1,538) $(1,979) $(3,724)
</TABLE>
- --------
(1) Includes a one-time expense of $4.1 million in the first quarter of 1995
from the Company's termination of exclusive distribution rights of its
European distributor. See Note 10 of Notes to Financial Statements.
(2)See Note 1 of Notes to Financial Statements.
18
<PAGE>
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Financial
Statements and the Notes thereto included elsewhere in this Form 10-K. This
discussion contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in the forward-looking statements as a result of certain factors,
including, but not limited to those discussed in "Risk Factors".
OVERVIEW
CONNECT designs, develops, markets and supports packaged application
software for Internet-based interactive commerce. The Company was founded in
1987 to provide online information services to businesses. During the period
1987 through 1992, the Company's primary business was the operation and
management of a private online service and the licensing of related client
software. In 1993 and 1994, the Company also offered software for creation,
access and operation of custom online systems. In late 1994, the Company began
to shift its focus from providing online services to developing packaged
software applications for Internet-based interactive commerce. During 1994 and
1995, the Company derived a significant portion of its revenue from contract
software development projects with two companies under which the Company
retained ownership of the technology developed. These projects formed the
foundation for the development of OneServer, the Company's core software
application, which was commercially released in September 1995, and
OrderStream, the first preconfigured implementation of OneServer, which was
commercially released in June 1996.
As of December 31, 1996, the Company had licensed either OneServer or
OrderStream to over 20 customers. The Company believes that the majority of
its 1997 revenue will be generated through licenses of OneServer and
OrderStream, and the performance of related services. The Company expects that
revenue from the operation of private online services will constitute a
decreasing portion of the Company's overall revenue in the future. As a result
of the recent transition in the Company's business, the Company's past results
of operations should not be relied upon as indicative of future results.
The Company derives revenue from software license fees and services. License
fees primarily consist of revenue from licenses of the Company's application
software. Service revenue consists of fees from implementation (including
customization of licensed software), training, maintenance and support,
contract software development projects, and system hosting and online
services. License revenue is recognized on shipment of the application
software provided there are no significant remaining obligations and
collectability is deemed probable by management. License fees under contracts
requiring significant implementation, including customization, of licensed
application software are recognized on a percentage-of-completion basis.
Revenue from implementation services is recognized as the services are
performed, except for revenue from certain fixed price contracts which is
recognized on a percentage-of-completion basis. Actual costs and gross margins
on fixed price contracts could differ from management's estimates and such
differences could be material to the financial statements.
The Company also enters into maintenance agreements in connection with
licenses of its application software under which revenue is recognized ratably
over the term of the agreement, generally one year. Usage fees related to the
Company's training, system hosting services, private online services and
consulting services are recognized as the services are performed.
Additionally, service revenue from contract software development projects, in
which the Company develops specific technology for its customers, has been
recognized on a percentage-of-completion basis.
The Company has incurred net losses in each fiscal year since inception and,
as of December 31, 1996, had an accumulated deficit of $47 million. The
Company's operating expenses have increased substantially since 1994 as the
Company made investments related to the development and introduction of
OneServer and OrderStream. To date, all research and development costs have
been expensed as incurred and have not been
19
<PAGE>
capitalized because capitalizable costs have not been material. The Company
anticipates that operating expenses will continue to increase for the
foreseeable future as it continues to develop its technology, increase sales
and marketing efforts and establish and expand distribution channels.
Accordingly, the Company expects to incur additional losses on a quarterly and
annual basis for the foreseeable future.
The Company's prospects are dependent upon the successful acceptance of
OneServer and OrderStream by the market, and must be evaluated in light of the
risks and uncertainties frequently encountered by companies dependent upon
such early stage products. In addition, the Company's markets are new and
rapidly evolving, which heightens these risks and uncertainties. To address
these risks, the Company must, among other things, successfully implement its
marketing strategy, respond to competitive developments, continue to develop
and upgrade its products and technologies more rapidly than its competitors,
and commercialize its products and services incorporating these enhanced
technologies. There can be no assurance that the Company will succeed in
addressing any or all of these risks. See "Risk Factors".
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of total revenue, items from
the Company's statements of operations for the periods indicated.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Revenue:
License................................................... 46% 3% 20%
Service................................................... 54 97 80
---- ---- ---
Total revenue............................................ 100 100 100
Cost of revenue:
License................................................... 8 2 2
Service................................................... 81 63 56
---- ---- ---
Total cost of revenue.................................... 89 65 58
Operating expenses:
Research and development.................................. 46 56 20
Sales and marketing....................................... 103 47 17
General and administrative................................ 23 39 24
Termination of distribution rights........................ -- 47 --
---- ---- ---
Total operating expenses................................. 172 189 61
---- ---- ---
Loss from operations....................................... (161) (154) (19)
Other income (expense)..................................... 2 (11) (3)
---- ---- ---
Loss before income taxes................................... (159) (165) (22)
Provision (benefit) for income taxes -- -- --
---- ---- ---
Net loss................................................... (159)% (165)% (22)%
==== ==== ===
Gross margin:
License................................................... 83% 51% 90%
Service................................................... (51)% 34% 30%
</TABLE>
20
<PAGE>
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
Revenue
License. License revenue was $4.7 million in 1996, $287,000 in 1995, and
$1.6 million in 1994. The revenue in 1994 was attributable to software
introduced in 1993 for creation, access and operation of custom online
services. The decrease in license revenue from 1994 to 1995 resulted primarily
from a decrease in licenses of such software as the Company refocused its
sales and marketing efforts on OneServer. The increase in 1996 results from
fees from licenses of the Company's OneServer and OrderStream application
software which were first licensed in the fourth quarter of 1995 and in the
second quarter of 1996, respectively. See "Business--Customers."
Service. Service revenue was $5.5 million in 1996, $8.3 million in 1995, and
$6.3 million in 1994. The increase in service revenue from 1994 to 1995 was
attributable primarily to revenue from the Development Projects. During the
first half of 1995 service revenue consisted primarily of revenue associated
with contract software development projects with AT&T Corporation ("AT&T") and
Electronic Marketplace Systems, Inc.,
both of which were completed in June 1995 (the "Development Projects"). The
later half of 1995's Service Revenue was primarily from private online
services. Service revenue in 1996 consisted of $2.5 million of revenue from
private online services and $3.0 million of revenue from implementation and
hosting services in connection with OneServer and OrderStream licenses. 1996
Service revenue was lower than 1995 primarily due to the completion of the
Development Projects. The Company expects in the future that service revenue
will decline as a percentage of total revenue due to the Company's focus on
licensing OneServer and OrderStream.
Costs of Revenue
Cost of License. Cost of license revenue includes sublicense fees and
expenses relating to product media, duplication and manuals. Cost of license
revenue was $.8 million in 1996, $.1 million in 1995 and $.2 million in 1994,
representing 17%, 49% and 10% of license revenue respectively. The increase in
cost in 1996 is primarily related to the costs of documentation and third
party royalties on the sale of OneServer and OrderStream.
Cost of Service. Cost of service revenue consists of: costs of
implementation services including fees of third-party contract developers and
Company personnel costs; training and customer support costs for OneServer;
costs associated with contract software development projects; and
telecommunications, personnel costs and depreciation related to hosting
services and the operation of the Company's private online service. Cost of
service revenue was $8.3 million in 1996, $5.5 million in 1995 and $4.4
million in 1994. Cost of services as a percentage of service revenue was 151%,
66% and 70% for 1996, 1995 and 1994 respectively. The $1.1 million increase in
cost of service revenue from 1994 to 1995 was due primarily to the cost of
converting the Company's private online service from a mainframe to a UNIX-
based environment, and costs associated with the Development Projects, as well
as increased operating costs of the private online service. In 1996, the $2.8
million increase in cost of service revenue was impacted by charges totaling
approximately $2.5 million in connection with certain fixed price contract
obligations to implement the Company's software for customers, and costs
associated with the Company's private online service and support of its
hosting customers on a 7x24 hour basis. The charges related to fixed price
contracts were due to implementation costs which are projected to exceed the
implementation fees due under the agreements. The charges were recorded in
1996 in accordance with generally accepted accounting principles which provide
that such charges must be recorded when they are probable and reasonably
estimable. From time to time the Company may continue to enter into fixed
price arrangements for its implementation services. Fixed price arrangements
could result in future losses if there are delays or cost increases in
implementation services or complexities associated with completion of the
projects. See "Risk Factors--Risks Associated with Complex Software Products;
Lengthy Sales and Implementation Cycles".
Operating Expenses
Research and Development. Research and development expenses consist
primarily of personnel and equipment costs. Research and development expenses
were $4.7 million in 1996, $4.8 million in 1995 and $1.6 million in 1994.
Research and development expenses, as a percentage of total revenue were 46%,
56% and 20%
21
<PAGE>
in 1996, 1995, and 1994 respectively. A significant portion of the initial
development costs related to OneServer were included in cost of service in
1994 and 1995 as such development was performed under the Development
Projects. The increase in research and development expenses from 1994 to 1995
was attributable primarily to increased staffing and associated support costs
of software engineers required to develop OneServer. The slight decrease in
research and development expenses in total dollars and as a percentage of
total revenue in 1996 was attributable to relatively consistent staffing and
associated support costs of software engineers required to expand and enhance
the Company's product line, including development of OneServer and
OrderStream. The Company expects research and development expense to increase
in absolute dollars.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and commissions of sales and marketing personnel, and travel,
marketing and promotional expenses. Sales and marketing expenses were $10.4
million in 1996, $4.0 million in 1995 and $1.4 million in 1994, representing
103%, 47% and 17% of total revenue for each respective period. The increase in
sales and marketing expenses from 1995 to 1996 and from 1994 to 1995 in
absolute dollars and as a percentage of revenue was attributable to building a
direct sales force and increasing marketing and promotional activities
directed at developing the Company's position in the emerging Internet-based
packaged application software market. Prior to 1996, a large portion of the
Company's revenue was generated without any related commission expense as such
revenue was largely comprised of non-commissioned services. This changed in
1996 with the growth of the commissioned sales force. The Company expects
sales and marketing expenses to increase in absolute dollars both as a result
of higher marketing and sales costs related to increased promotional
activities and increased commission expense associated with licenses.
General and Administrative. General and administrative expenses consist
primarily of salaries of financial, administrative and management personnel
and related travel expenses, as well as legal and accounting expenses. General
and administrative expenses were $2.4 million in 1996, $3.3 million in 1995
and $1.9 million in 1994. The increase in general and administrative expenses
from 1994 to 1995 resulted primarily from the addition of personnel, including
two senior executives, and expenses associated with capital raising
activities. General and administrative expenses decreased $.9 million and as a
percentage of total revenue from 39% in 1995 to 23% in 1996 due primarily to
lower professional service fees and to lower total costs incurred compared to
total revenue generated in the 1996 period. In the foreseeable future, the
Company expects general and administrative expenses to increase in absolute
dollars.
Termination of Distribution Rights. The Company incurred charge to
operations of $4.1 million 1995 related to its termination of exclusive
European distribution rights of its former European distributor. The
distributor had acquired exclusive rights for distributing certain of the
Company's software and services in Europe. The Company negotiated the
termination of the distributor's rights primarily because the distributor was
not performing to the Company's standards and the Company wanted to
reestablish control over its European distribution channel.
Other Income (Expense)
Other income (expense) consists primarily of interest expense and interest
income. Interest expense, which results principally from interest incurred
under notes payable and capital lease obligations, was $331,000 in 1996, $1.0
million in 1995, and $240,000 in 1994. The larger interest exepense level in
1995 is due to the larger equipment lease and notes payable balances. Interest
income and other, which results principally from interest earned on cash
balances, was $547,000 in 1996, $32,000 in 1995, and $41,000 in 1994. The
increase in interest income in 1996 is attributable to the earnings on cash
balances from the December 1995 private financing and the 1996 initial public
offering of the Company's common stock.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations to date primarily through the
private and public sale of equity securities and the use of capitalized leases
for equipment financing. The Company has working capital of $10.3 million at
December 31, 1996.
22
<PAGE>
Net cash used in operating activities in 1996 was $14.0 million resulting
primarily from a net loss, offset in part by an increase in accrued
liabilities. Net cash used in operating activities in 1995 was $14.9 million.
This consisted primarily of net losses plus a decrease in deferred revenue,
offset in part by the issuance of stock in connection with the termination of
the Company's contract with its German distributor. Net cash generated by
operating activities was $1.4 million in 1994.
During 1996, 1995 and 1994 the Company used $2.0 million, $1.8 million and
$1.6 million, respectively, in investing activities, as a result of the
purchase of property and equipment. Net cash provided by financing activities
in 1996, 1995 and 1994 was $15.3 million, $28.0 million and $1.8 million,
respectively. Net cash provided by financing activities in 1996 resulted
primarily from net proceeds of $12.1 million from the Company's initial public
offering of its common stock in August 1996, and net proceeds of $3.9 million
from the issuance of preferred stock. See "Certain Relationships and Related
Transactions." Net cash provided by financing activities in 1995 resulted
primarily from the Company's private equity financing in December 1995.
On January 8, 1997 the Company obtained a commitment for a $2,000,000 line
of credit to be secured by equipment, furniture and fixtures. The Company may
seek advances against the line of credit throughout 1997. Each advance must be
at least $50,000 and secured by specific unencumbered equipment. Amounts
advanced are to be repaid over a period of up to four years at an effective
annual interest rate of approximately 15% per year.
The Company believes that the existing cash balances and funds that may be
generated from operations will be sufficient to finance the Company's
currently anticipated working capital requirements through the end of 1997.
There can be no assurance, however, that the Company's actual needs will not
exceed anticipated levels, or that the Company will generate sufficient
revenue to fund its operations in the absence of other sources. There also can
be no assurance that any additional required financing will be available
through bank borrowings, debt or equity offerings or otherwise, or that if
such financing is available, it will be available on terms favorable to the
Company or its stockholders.
23
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONNECT, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.......................... 25
Balance Sheets............................................................. 26
Statements of Operations................................................... 27
Statements of Stockholders' Equity......................................... 28
Statements of Cash Flows................................................... 29
Notes to Financial Statements.............................................. 30
</TABLE>
24
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
CONNECT, Inc.
We have audited the accompanying balance sheets of CONNECT, Inc. as of
December 31, 1996 and 1995, and the related statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of CONNECT, Inc., at December
31, 1996, and 1995, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
Ernst & Young LLP
San Jose, California
January 24, 1997
25
<PAGE>
CONNECT, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1995
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $12,214,042 $12,928,911
Accounts receivable, less allowances for doubtful
accounts of $222,000 at December 31, 1996 and
$320,000 at December 31, 1995..................... 2,533,890 1,009,624
Prepaid expenses and other current assets.......... 605,682 471,819
----------- -----------
Total current assets................................. 15,353,614 14,410,354
Property and equipment, net.......................... 3,646,809 3,263,030
Deposits and other assets............................ 153,974 389,145
----------- -----------
Total assets................................... $19,154,397 $18,062,529
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable...................................... $ 61,456 $ 194,938
Accounts payable................................... 1,688,280 621,806
Accrued payroll and related expenses............... 941,029 305,772
Other accrued liabilities.......................... 1,321,270 708,211
Deferred revenue................................... 189,142 422,984
Current portion of extended vendor liabilities..... 260,458 252,192
Obligations under capital leases................... 547,786 602,292
----------- -----------
Total current liabilities............................ 5,009,421 3,108,195
Notes payable...................................... 9,066 67,009
Long-term portion of extended vendor liabilities... 417,433 656,269
Long-term obligations under capital leases......... 363,672 912,902
Commitments and contingencies
Stockholders' equity:
Preferred stock:
Authorized shares--10,000,000
Issued and outstanding--none....................... -- --
Convertible preferred stock:
Authorized shares--none at December 31, 1996 and
55,544,540 at December 31, 1995................. -- -
Issued and outstanding shares--none at December
31, 1996 and 14,112,899 at December 31, 1995.... -- 37,041,259
Common stock: $.001 par value at December 31, 1996
and no par value at December 31, 1995
Authorized shares--40,000,000 at December 31,
1996 and 50,000,000 at December 31, 1995........ -- --
Issued and outstanding shares--18,531,467 at
December 31, 1996 and 398,624 at December 31,
1995............................................ 18,531 7,107,474
Additional paid-in capital......................... 60,448,304 --
Deferred compensation.............................. (139,411) --
Accumulated deficit................................ (46,972,619) (30,830,579)
----------- -----------
Total stockholders' equity........................... 13,354,805 13,318,154
----------- -----------
Total liabilities and stockholders' equity........... $19,154,397 $18,062,529
=========== ===========
</TABLE>
See accompanying notes.
26
<PAGE>
CONNECT, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
------------ ------------ -----------
<S> <C> <C> <C>
Revenue:
License............................. $ 4,693,068 $ 287,471 $ 1,627,294
Service............................. 5,486,720 8,285,427 6,344,746
------------ ------------ -----------
Total revenue..................... 10,179,788 8,572,898 7,972,040
Cost of revenues:
License............................. 790,652 139,961 162,471
Service............................. 8,277,358 5,451,893 4,425,893
------------ ------------ -----------
Total cost of revenue............. 9,068,010 5,591,854 4,588,364
Operating expenses:
Research and development............ 4,652,633 4,810,166 1,622,081
Sales and marketing................. 10,444,510 3,978,361 1,354,844
General and administrative.......... 2,372,702 3,329,400 1,946,731
Termination of distribution rights.. -- 4,057,292 --
------------ ------------ -----------
Total operating expenses.......... 17,469,845 16,175,219 4,923,656
------------ ------------ -----------
Loss from operations.................. (16,358,067) (13,194,175) (1,539,980)
Interest expense...................... (330,913) (1,002,761) (239,943)
Interest income and other income
(expense), net....................... 546,940 32,005 41,388
------------ ------------ -----------
Loss before income taxes.............. (16,142,040) (14,164,931) (1,738,535)
Provision (benefit) for income taxes.. -- (26,000) 26,000
------------ ------------ -----------
Net loss.............................. $(16,142,040) $(14,138,931) $(1,764,535)
============ ============ ===========
Pro forma net loss per share.......... $(0.90) $(0.79)
============ ============
Shares used in computing pro forma net
loss per share....................... 17,910,939 17,813,739
============ ============
</TABLE>
27
<PAGE>
CONNECT, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK TOTAL
------------------------ ---------------------- DEFERRED ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT COMPENSATION DEFICIT EQUITY (DEFICIT)
----------- ----------- ---------- ----------- ------------ ------------ ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1993................... 2,519,892 $ 5,890,743 246,062 $ 7,057,206 -- $(14,927,113) $(1,979,164)
Issuance of Series E
preferred stock for
cash................... 437,715 1,532,001 -- -- -- -- 1,532,001
Exercise of employee
stock options.......... -- -- 123,923 36,351 -- -- 36,351
Conversion of notes
payable to stockholders
to Series E preferred
stock, net of issuance
costs of $30,856....... 190,857 637,144 -- -- -- -- 637,144
Net loss................ -- -- -- -- -- (1,764,535) (1,764,535)
----------- ----------- ---------- ----------- --------- ------------ -----------
Balance at December 31,
1994................... 3,148,464 8,059,888 369,985 7,093,557 -- (16,691,648) (1,538,203)
Conversion of notes
payable to stockholders
and accrued interest
for Series D preferred
stock.................. 58,821 152,933 -- -- -- -- 152,933
Termination of
distribution rights
settled in Series E
preferred stock........ 175,000 1,417,500 -- -- -- -- 1,417,500
Issuance of Series F
preferred stock for
cash and notes, net of
issuance costs of
$917,888............... 10,730,614 27,410,938 -- -- -- -- 27,410,938
Exercise of employee
stock options and
other.................. -- -- 28,639 13,917 -- -- 13,917
Net loss................ -- -- -- -- -- (14,138,931) (14,138,931)
----------- ----------- ---------- ----------- --------- ------------ -----------
Balance at December 31,
1995................... 14,112,899 37,041,259 398,624 7,107,474 -- (30,830,579) 13,318,154
Issuance of Series F
preferred stock for
cash................... 360,000 937,849 -- -- -- -- 937,849
Issuance of Series G
preferred stock for
cash. 272,750 2,963,532 -- -- -- -- 2,963,532
Issuance of common stock
in connection with
initial public
offering............... -- -- 2,400,000 12,130,474 -- -- 12,130,474
Conversion of preferred
to common stock........ (14,745,649) (40,942,640) 15,503,303 40,942,640 -- -- --
Exercise of warrants.... -- -- 106,482 3,970 -- -- 3,970
Exercise of employee
stock options and
other, net of
repurchases............ -- -- 123,058 112,844 -- -- 112,844
Deferred compensation
related to grant of
stock options.......... -- -- -- 169,433 (169,433) -- --
Amortization of deferred
compensation........... -- -- -- -- 30,022 -- 30,022
Net loss................ -- -- -- -- -- (16,142,040) (16,142,040)
----------- ----------- ---------- ----------- --------- ------------ -----------
Balance at December 31,
1996................... -- $ -- 18,531,467 $60,466,835 $(139,411) $(46,972,619) $13,354,805
=========== =========== ========== =========== ========= ============ ===========
</TABLE>
See accompanying notes.
28
<PAGE>
CONNECT, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
------------ ------------ -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss.............................. $(16,142,040) $(14,138,931) $(1,764,535)
Adjustments to reconcile net loss to
net cash provided by (used in)
operating activities:
Depreciation and amortization....... 1,674,757 987,829 473,351
Amortization of deferred
compensation....................... 30,022 -- --
Termination of distribution rights
settled in Series E preferred
stock.............................. -- 1,417,500 --
Deferred income tax................. -- 77,000 (77,000)
Changes in operating assets and
liabilities:
Accounts receivable............... (1,524,266) (280,679) 77,059
Prepaid expenses and other current
assets........................... (133,863) (124,503) (111,038)
Deposits and other assets......... 235,171 (215,882) (173,263)
Accounts payable, accrued payroll
and related expenses, other
accrued liabilities, and extended
vendor liabilities............... 2,084,220 (52,153) 65,162
Deferred revenue.................. (233,842) (2,562,834) 2,887,190
------------ ------------ -----------
Net cash provided by (used in)
operating activities............. (14,009,841) (14,892,653) 1,376,926
INVESTING ACTIVITIES
Purchases of property and equipment... (2,044,533) (1,772,591) (1,627,126)
FINANCING ACTIVITIES
Proceeds from sale and leaseback of
equipment at net book value.......... -- 1,197,393 --
Proceeds from issuance of common
stock................................ 12,247,288 13,917 36,351
Proceeds from issuance of preferred
stock................................ 3,901,381 28,328,826 1,532,001
Issuance costs associated with
conversion of notes payable and
issuance of preferred stock.......... -- (917,888) (30,856)
Proceeds from issuance of notes
payable converted into Series E
preferred stock...................... $ -- $ -- $ 668,000
Proceeds from issuance of notes
payable.............................. -- 133,534 43,090
Repayment of principal on notes
payable.............................. (191,425) (180,974) (149,677)
Repayment of principal under capital
lease obligations.................... (617,739) (574,524) (318,987)
------------ ------------ -----------
Net cash provided by financing
activities........................... 15,339,505 28,000,284 1,779,922
------------ ------------ -----------
Net increase (decrease) in cash and
cash equivalents..................... (714,869) 11,335,040 1,529,722
Cash and cash equivalents at beginning
of period............................ 12,928,911 1,593,871 64,149
------------ ------------ -----------
Cash and cash equivalents at end of
period............................... $12,214,042 $12,928,911 $1,593,871
============ ============ ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Cash paid year for interest.......... $ 328,448 $ 373,948 $ 239,943
Cash paid for income taxes............ $ 1,100 -- $ 8,500
SUPPLEMENTAL NONCASH INVESTING AND
FINANCING INFORMATION
Notes payable to stockholders,
including $26,583 of accrued
interest, converted into Series D
preferred stock...................... -- $ 152,933 --
Capital lease obligations incurred... $ 14,003 $ 332,084 $ 355,955
</TABLE>
See accompanying notes.
29
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. ORGANIZATION
CONNECT (the "Company") designs, develops, markets and supports packaged
application software for Internet-based interactive commerce. The Company was
founded in 1987 to provide online information services to businesses. During
the period 1987 through 1992, the Company's primary business was the operation
and management of a private online service and the licensing of related client
software. In 1993 and 1994, the Company also offered software for creation,
access and operation of custom online systems. In late 1994, the Company began
to shift its focus from providing online services to developing packaged
software applications for Internet-based interactive commerce. During 1994 and
1995, the Company derived a significant portion of its revenue from contract
software development projects with two companies under which the Company
retained ownership of the technology developed. These projects formed the
foundation for the development of OneServer, the Company's core software
application, which was commercially released in September 1995, and
OrderStream, the first preconfigured implementation of OneServer, which was
commercially released in June 1996.
For the year ended December 31, 1996, the Company derived all of its license
revenues and 75% of total revenues from its OneServer and OrderStream products
and services.
The Company has incurred net losses and experienced significant negative
cash flow from operations since inception. As of December 31, 1996, the
Company had an accumulated deficit of approximately $47 million. Based upon
its current operating plan, the Company believes it has adequate cash and
investment balances to fund its operations through December 31, 1997. There
can be no assurance, however, that the Company's actual cash requirements will
not exceed anticipated levels, or that the Company will generate sufficient
revenue to fund its operations in the absence of additional funding sources.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Concentration of Credit Risk
The Company licenses products and provides services to a variety of
customers. The Company generally does not perform credit evaluations or
require collateral on individual customer service or license transactions that
involve relatively small amounts. However, credit worthiness on larger service
or license transactions are evaluated on a case-by-case basis.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity (at the date of purchase) of three months or less to be cash
equivalents. The Company has classified all debt securities as available-for-
sale. Available-for-sale securities are carried at cost which approximates
fair value. Unrealized gains and losses, if material, are reported in a
separate component of stockholders' equity. Realized gains and losses and
declines in value judged to be other-than-temporary are included in interest
income and other, net.
30
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
All of the Company's available-for-sale securities mature in three months or
less and are included in cash and cash equivalents. Available for sale
securities at December 31, 1996 and 1995 totaled $8,935,132 and $12,314,990,
respectively, and are comprised of U.S. government obligations. At December
31, 1996 and 1995, gross unrealized gains and losses were not significant.
There were no gross realized gains or losses on available-for-sale securities
for 1996, 1995, and 1994.
Property and Equipment
Property and equipment are stated at cost and are depreciated on a straight-
line basis over their estimated useful lives of three to seven years.
Leasehold improvements are amortized on a straight-line basis over the shorter
of the lease term or the estimated useful life of the improvements.
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1995
---------- ----------
<S> <C> <C>
Computer equipment.................................. $3,523,022 $2,184,932
Equipment under capital leases...................... 2,307,869 2,589,818
Furniture and fixtures.............................. 225,521 173,206
Leasehold improvements.............................. 619,331 400,322
---------- ----------
6,675,743 5,348,278
Accumulated depreciation and amortization........... 3,028,934 2,085,248
---------- ----------
$3,646,809 $3,263,030
========== ==========
</TABLE>
Revenue Recognition and Deferred Revenue
The Company derives revenue from software license fees and services. License
fees consist primarily of revenue from licenses of the Company's application
software. Service revenue consists of fees from implementation (including
customization of licensed software products), training, maintenance and
support, contract software development projects, system hosting and online
services.
License Revenue
The Company licenses application software to end-users under non-cancelable
license agreements. License revenue is recognized on shipment of the
application software provided there are no significant remaining obligations
and collectability is deemed probable by management. License fees under
contracts requiring significant implementation, including customization of
licensed software products are recognized on the percentage-of-completion
method based on the ratio of incurred costs to total estimated costs. Actual
costs and gross margins on such contracts could differ from management's
estimates and such differences could be material to the financial statements.
Provisions for estimated losses on uncompleted contracts are made in the
period in which such losses are determined.
Service Revenue
Fees for implementation services are recognized as the services are
performed, except for such fees under fixed price contracts which are
recognized on the percentage-of-completion method as noted above.
31
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
The Company also enters into maintenance agreements in connection with
licenses of its application software under which revenue is recognized ratably
over the term of the agreement, generally one year. Usage fees related to the
Company's private online services, system hosting services, training and other
consulting services are recognized as the services are performed.
Revenue from contract software development projects, in which the Company
developed specific technology for its customers, has been recognized on the
percentage-of-completion method based on the ratio of incurred costs to total
estimated costs.
Deferred Revenue
Deferred revenue includes collections in excess of revenue recognized on
development arrangements, deferred maintenance, and other payments received in
advance of services to be performed.
Research and Development
Research and development expenditures are generally charged to operations as
incurred. Statement of Financial Accounting Standards No. 86, "Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,"
requires the capitalization of certain software development costs subsequent
to the establishment of technological feasibility. Based on the Company's
product development process, technological feasibility is established upon the
completion of a working model. Costs incurred by the Company between the
completion of the working model and the point at which the product is ready
for general release have been insignificant. Accordingly, the Company has
charged all such costs to research and development expenses in the
accompanying statements of operations.
Advertising and Promotion Costs
The Company's policy is to expense advertising and promotion costs as they
are incurred. The Company's advertising and promotion expenses were
approximately $1,064,000, $372,000, and $238,706 in 1996, 1995, and 1994,
respectively.
Income Taxes
Income taxes are accounted for under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes." Under this method, deferred
tax assets and liabilities are determined based on differences between the
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
Net Loss Per Share
Except as noted below, net loss per share is computed using the weighted
average number of shares of common stock outstanding. Common equivalent shares
from convertible preferred stock (using the if-converted method) and from
stock options and warrants (using the treasury stock method) have been
excluded in the computation because the effect is anti-dilutive. Pursuant to
the Securities and Exchange Commission Staff Accounting Bulletins, common and
common equivalent shares issued by the Company at prices below the initial
public offering price during the twelve-month period prior to the initial
public offering have been included in the calculation as if they were
outstanding for all periods presented through June 30, 1996 (using the
treasury stock method at the $6.00 per share initial public offering price.)
The difference between primary and fully diluted earnings per share is not
material for all periods presented.
32
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
Per share information calculated on the above noted basis is as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Net loss................................ $ (1.16) $ (1.03) $ (0.13)
========== ========== ==========
Shares used in computing net loss per
share.................................. 13,941,826 13,667,081 13,593,574
========== ========== ==========
</TABLE>
Pro Forma Net Loss Per Share
Pro forma net loss per share presented in the Statements of Operations is
computed as described above and also gives effect, even if antidilutive, to
common equivalent shares from convertible preferred stock, from the date of
issuance, that automatically converted to common stock upon the closing of the
Company's initial public offering (using the if-converted method).
Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued Statement
of Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("FAS 123"). The Company adopted FAS123 in 1996. The Company accounts for
employee stock options in accordance with Accounting Principles Board Opinion
No. 25 and has adopted the "disclosure only" alternative described in FAS 123.
3. NOTES PAYABLE
At December 31, 1996 the Company has two notes payable with remaining
principal balances of $13,327 and $57,195. These unsecured notes bear interest
at 11% and are due in monthly payments through December 15, 1997, and March 1,
1998, respectively.
4. EXTENDED VENDOR LIABILITIES
During 1992 and 1993, the Company renegotiated payment terms with a number
of its largest vendors. The resulting agreements bear interest at rates
ranging from 0% to 8%, and certain of the repayment agreements extend beyond
one year.
In April 1994, the Company terminated its service and license agreement with
a vendor, resulting in a reduction of $253,656 in extended vendor liabilities.
In addition, the repayment terms for certain amounts due the vendor were
extended from three to five years. Beginning in December 1994, the total
liability due the vendor of $1,000,000 will be due in monthly installments,
plus interest, at an annual rate of 6% through November 1999.
Principal payments due in each calendar year as of December 31, 1996
relating to the above agreements are as follows:
<TABLE>
<S> <C>
1997............................................................. $260,458
1998............................................................. 211,579
1999............................................................. 205,854
--------
$677,891
========
</TABLE>
33
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
5. COMMITMENTS AND CONTINGENCIES
Operating Leases
The lease agreement for the Company's primary facility expires December 9,
1999. At December 31, 1996, the future minimum lease payments related to
operating lease agreements are as follows:
<TABLE>
<S> <C>
1997........................................................... $ 465,752
1998........................................................... 407,987
1999........................................................... 400,924
2000........................................................... 95,583
2001........................................................... 98,451
----------
$1,468,697
==========
</TABLE>
Rental expense for 1996, 1995 and 1994, was $290,690, $317,690, $307,058,
respectively.
Capital Leases
The Company leases certain equipment under capital leases having terms of 36
to 42 months. Accumulated amortization on these assets was $1,196,394 and
$988,848 at December 31, 1996 and 1995, respectively.
The following is a schedule by year of future minimum lease payments under
capital leases as of
December 31, 1996:
<TABLE>
<S> <C>
1997........................................................... $ 692,298
1998........................................................... 390,270
1999........................................................... 1,235
---------
Total minimum lease payments................................... 1,083,803
Amount representing interest................................... 172,345
---------
911,458
Less current portion........................................... 547,786
---------
$ 363,672
=========
</TABLE>
Contingencies
On March 25, 1996, one of the Company's licensees of OneServer (the
"Customer") was sued, along with 21 other defendants in the Federal District
Court in Connecticut, by E-data Corporation ("E-data"), in which E-data
alleges that each defendant is infringing E-data's U.S. patent in connection
with electronic distribution of images on the Internet. The Customer has
tendered the defense of this litigation to the Company. The Company has
reviewed the infringement claims made by E-data against the Customer. Based
upon this review of the E-data patent and the nature of the claims and the
Company's indemnity obligations, and after consultation with counsel,
management believes that the resolution of this matter will not have a
material adverse effect on the Company's business, operating results and
financial condition. However, given the early stage of the litigation and the
complex technical issues and uncertainties in patent litigation, the results
of these proceedings, including any potential settlement, are uncertain and
there can be no assurance that E-data will not prevail in the current
litigation or that it will not bring similar claims against other licensees of
the Company. If E-data were to prevail, the Customer could be required to pay
damages to E-data for the infringement of its patent and enter into a
licensing or royalty arrangement. There can be no assurance that the amount of
such damages would not be material or that such license or royalty arrangement
would be available on acceptable terms. Under the terms of
34
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
its license with the Customer, the Company may be required to defend against
the E-data claim and to indemnify the Customer for some or all of its losses
in connection with the litigation and any settlement or judgement, including
ongoing license fees. In addition, whether or not the Company were to prevail
in any defense of the Customer, such litigation could be time consuming and
costly to defend.
6. PREFERRED STOCK
Convertible preferred stock consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
-------- -----------
<S> <C> <C>
Series C preferred stock:
Authorized shares-none at December 31, 1996 and
2,240,130 at December 31, 1995
Issued and outstanding shares--none at December 31,
1996 and 1,118,080 at December 31, 1995............ -- $ 2,248,713
Series D preferred stock:
Authorized shares--none at December 31, 1996 and
2,921,266 at December 31, 1995
Issued and outstanding shares--none at December 31,
1996 and 1,460,633 at December 31, 1995............ -- 3,794,963
Series E preferred stock:
Authorized shares--none at December 31, 1996 and
1,757,144 at December 31, 1995
Issued and outstanding shares--none at December 31,
1996 and 803,572 at December 31, 1995.............. -- 3,586,645
Series F preferred stock:
Authorized shares--none at December 31, 1996 and
24,313,000 at December 31, 1995
Issued and outstanding shares--none at December 31,
1996 and 10,730,614 at December 31, 1995........... -- 27,410,938
Series F-a preferred stock:
Authorized shares--none at December 31, 1996 and
24,313,000 at December 31, 1995
Issued and outstanding shares--none................. -- --
-------- -----------
Total convertible preferred stock.................... -- $37,041,259
======== ===========
</TABLE>
On July 3, 1996, the Company issued 272,750 shares of Series G convertible
preferred stock to a customer of the Company for approximately $3,000,000 in
cash.
In August 1996, the Company completed its initial public offering of
2,400,000 shares of common stock. The Company received net proceeds of
approximately $12.2 million after deducting expenses and underwriting
discounts. Upon closing of the offering, all then outstanding preferred stock
converted into 15,503,303 shares of common stock.
35
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
7. EMPLOYEE BENEFIT PLAN
The Company maintains an employee savings plan that qualifies under Section
401(k) of the Internal Revenue Code (the "Code") for all of its full-time
employees. The plan allows employees to make specified percentage pre-tax
contributions up to the maximum dollar limitation prescribed by the Code. The
Company has the option to contribute to the plan; however, there have been no
Company contributions to date.
8. STOCK OPTION AND STOCK PURCHASE PLANS
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement 123, "Accounting for Stock-based Compensation" requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
The Company maintained a 1989 Stock Option Plan that authorized the issuance
of up to 2,700,000 shares of common stock. A committee, as appointed by the
Board of Directors, granted incentive or nonqualified stock options. Options
are generally granted at an exercise price of no less than the fair value per
share of the common stock on the date of grant as determined by the Board of
Directors. The options issued under the 1989 Plan generally vest over four
years and are immediately exercisable, expiring no later than ten years from
the date of grant. Unvested shares may be repurchased by the Company at the
original purchase price.
In 1996, the stockholders approved the adoption of the 1996 Stock Option
Plan pursuant to which 2,500,000 shares of the Company's common stock have
been reserved. Options issued under the 1996 Stock Option Plan are generally
exercisable twelve months from the date of grant and vest over four years,
expiring no later than 10 years from the date of grant. Unvested shares may be
repurchased by the Company at the original purchase price.
In February 1996, the Company offered to each employee with stock options
having an exercise price greater than $0.50 per share the opportunity to amend
the terms of such options and reduce the exercise price to $0.50 per share (an
amount not less than fair market value, as deemed by the Board of Directors,
as of the offer date). The new options have the same vesting terms as the
surrendered options. Options representing 386,018 shares of common stock were
repriced, and have been included in option grants and cancellations in the
year ended December 31, 1996.
In September 1996, the Company offered to each employee with stock options
having an exercise price of $9.60 per share, or greater, the opportunity to
amend the terms of such options and reduce the exercise price to $6-1/8 per
share (an amount equal to the fair market value as of the offer date). The new
options have the same vesting terms as the surrendered options. Options
representing 430,650 shares of common stock were repriced, and have been
included in option grants and cancellations in the year ended December 31,
1996.
The Company maintains an Employee Stock Purchase Plan pursuant to which
500,000 shares of the Company common stock have been reserved for future
issuance. No shares have been issued through December 31, 1996. The Company
also maintains a Director's Stock Option Plan pursuant to which 250,000 shares
of common stock are reserved for future issuance. No options have been granted
under the Director's Stock Option Plan through December 31, 1996.
36
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
A summary of activity under the Stock Option Plans is as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
-------------------------------
SHARES WEIGHTED AVERAGE
AVAILABLE NUMBER OF PRICE EXERCISE PRICE
FOR GRANT SHARES PER SHARE PER SHARE
---------- --------- -------------- ----------------
<S> <C> <C> <C> <C>
Balance at December 31,
1993................... 187,370 473,275 $0.20 - $ 2.00
Additional shares
reserved.............. 164,000
Options granted........ (397,651) 397,651 $0.26 - $ 4.00
Options exercised...... -- (123,923) $0.20 - $ 0.70
Options canceled....... 99,981 (99,981) $0.20 - $ 2.00
---------- --------- --------------
Balance at December 31,
1994................... 53,700 647,022 $0.20 - $ 4.00
Additional shares
reserved.............. 1,845,000
Options granted........ (475,500) 475,500 $0.50 - $13.00
Options exercised...... -- (25,795) $0.20 - $ 4.00
Options canceled....... 59,595 (59,595) $0.26 - $13.00
---------- --------- --------------
Balance at December 31,
1995................... 1,482,795 1,037,132 $0.20 - $13.00
Additional shares
reserved.............. 2,500,000
Options granted........ (3,457,146) 3,457,146 $0.50 - $10.80 $3.01
Options exercised...... -- (146,564) $0.20 - $ 0.50 $0.42
Options canceled....... 994,347 (994,347) $0.20 - $13.00 $6.54
Options repurchased.... 23,501 -- $0.26 - $ 0.70 $0.50
---------- --------- --------------
Balance at December 31,
1996................... 1,543,497 3,353,367 $0.20 - $10.80 $1.87
========== ========= ==============
</TABLE>
At December 31, 1996, options to purchase 574,391 shares of common stock
were exercisable.
At December 31, 1996, 46,118 shares of common stock issued upon exercise of
options were subject to repurchase by the Company.
In connection with certain of the Company's stock options granted in 1996,
the Company recorded deferred compensation of $169,433 for the difference
between the option grant price and the deemed fair value of the Company's
common stock at the date of grant. The amount is being amortized over the
vesting period of the individual options, generally a 48 month period.
Amortization expense related to deferred compensation was $30,022 for the year
ended December 31, 1996.
37
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
The following table summarizes stock options outstanding and options
exercisable at December 31, 1996.
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ----------------------------------------------------- ------------------------
WEIGHTED
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
RANGE OF AS OF REMAINING AVERAGE AS OF AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
PRICES 1996 LIFE PRICE 1996 PRICE
-------- ------------ ----------- -------- ------------ --------
<S> <C> <C> <C> <C> <C>
$0.00 - $1.50 2,506,989 8.5 $ .46 574,391 $0.35
$1.51 - $3.75 15,450 9.3 $3.00 -- --
$3.76 - $5.25 100,250 9.5 $4.80 -- --
$5.26 - $6.50 706,178 9.5 $6.22 -- --
$6.51 - $7.75 11,500 9.9 $7.11 -- --
$7.76 - $8.25 13,000 9.8 $8.25 -- --
--------- ------- -----
3,353,367 8.9 $1.87 547,391 $0.35
--------- ------- -----
</TABLE>
Pro forma information regarding net loss and net loss per share is required
by FAS 123, which also requires that the information be determined as if the
Company had accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method. The fair value for these
options using the Black-Scholes option pricing model was estimated at the date
of grant using the following weighted average assumptions for the years ended
December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Risk fee interest rate 5.88% 6.17%
Dividend Yield none none
Volatility 17.9% 0%
Expected life of option in years 5 5
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information is as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1996 1995
------------ ------------
<S> <C> <C>
Pro forma net loss........................... $(16,675,027) $(14,154,076)
Pro forma net loss per share................. $ (1.20) $ (1.04)
</TABLE>
The pro forma net loss per share above does not assume the conversion of
preferred stock prior to completion of the initial public offering in August
1996, and is calculated using the weighted average number of shares of common
stock outstanding as described in Note 1.
The weighted average fair value of options granted during the years ended
December 31, 1996 and 1995 was $1.50 and $0.19, respectively. Because FAS123
is applicable only to options granted subsequent to December 31 1994, its pro
forma effects will not be fully reflected until the year ended December 31,
1999.
38
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
9. STOCK WARRANTS
In October 1992, the Company issued a warrant to purchase 13,919 shares of
common stock at $4.12 per share to a bank in connection with a note payable
that was paid in 1993. Upon proper notice the warrant expires October 15,
1997.
10. TERMINATION OF DISTRIBUTION RIGHTS
In December 1994, the Company signed an agreement that provided the Company
the option to terminate the marketing and distribution rights of its European
distributor. In connection with this option agreement, the Company paid its
European distributor a nonrefundable $250,000 fee which the Company expensed
in 1994. The Company exercised its option on March 13, 1995 and paid its
European distributor approximately $2,640,000 in cash and issued 175,000
shares of its Series E preferred stock. Due to impairment of the net
realizable value of the European distribution rights, the Company expensed all
payments made in connection with the transaction in 1995. The amount paid was
negotiated between the Company and its European distributor on an arm's-length
basis. The Company received an opinion from an independent financial advisor
as to the fair market value of the shares of Series E preferred stock at the
time of the negotiation to support its determination as to the value of the
amount paid.
11. MAJOR CUSTOMERS
Customers comprising 10% or greater of the Company's revenue are summarized
as follows:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
----------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Company A.................................................. -- 52% 22%
Company B.................................................. -- -- 12%
Company C.................................................. * * 12%
Company D.................................................. 13% -- --
</TABLE>
- --------
* Receives less than 10%.
12. INCOME TAXES
The components of the provision (benefit) for income taxes are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
------------------------
1996 1995 1994
------ -------- -------
<S> <C> <C> <C>
Federal:
Current........................................ $ -- $(94,000) $94,000
Deferred....................................... -- 77,000 (77,000)
------ -------- -------
-- (17,000) 17,000
State:
Current........................................ -- (9,000) 9,000
------ -------- -------
-- (9,000) 9,000
------ -------- -------
Provision (benefit) for income taxes............ -- $(26,000) $26,000
====== ======== =======
</TABLE>
39
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
The difference between the provision (benefit) for income taxes and the
amount computed by applying the federal statutory income tax rate to income
(loss) before taxes is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- ---------
<S> <C> <C> <C>
Tax at federal statutory rate....... $(5,650,000) $(4,958,000) $(591,000)
State taxes......................... -- (9,000) 9,000
Losses not currently benefited...... 5,650,000 4,941,000 608,000
----------- ----------- ---------
Provision (benefit) for income
taxes.............................. $ -- $ (26,000) $ 26,000
=========== =========== =========
</TABLE>
The components of deferred income taxes consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1996 1995
----------- ----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................ $11,100,000 $5,425,000
Research credit carryforwards................... 167,000 167,000
Deferred revenue................................ 200,000 195,000
Depreciation and amortization................... 1,800,000 1,561,000
Other........................................... 400,000 314,000
----------- ----------
Total deferred tax assets........................ 13,667,000 7,662,000
Valuation allowance.............................. (13,667,000) (7,662,000)
----------- ----------
Total net deferred taxes......................... $ -- $ --
=========== ==========
</TABLE>
A valuation allowance has been recorded for the entire deferred tax asset as
a result of uncertainties regarding the realization of the asset due to the
lack of earnings history of the Company. To support the Company's conclusion
that a full allowance was required, management primarily considered the
Company's history of operating losses and expected net losses for the
foreseeable future. The Company will continue to assess the realizability of
the deferred tax assets based on actual and forecasted operating results. The
valuation allowance increased by $6,005,000 in 1996 and $5,134,000 in 1995.
At December 31, 1996, the Company had available federal net operating loss
carryforwards of approximately $31,600,000, which will expire in 2010 through
2011, if not utilized. Also available at December 31, 1996 are federal
research credit carryforwards of approximately $167,000, which will expire in
2011, if not utilized. The Company's issuance of Series E preferred stock in
June 1994 was considered to have caused a change in ownership for the purpose
of the limitation on the utilization of net operating loss and research credit
carryforwards as set forth in the Internal Revenue Code. Accordingly,
approximately $3,800,000 of the Company's net operating loss carryforwards
will be subject to an annual limitation of approximately $360,000 per year.
The Company's issuance of Series F preferred stock in December 1995 also may
have caused a change in ownership so as to limit $15,500,000 of the Company's
net operating loss carryforwards to an annual limitation of approximately
$540,000 per year. In addition, the Company's issuance of Series C preferred
stock in 1992 resulted in a change in ownership that virtually eliminated the
future utilization of federal net operating losses and research credits at the
time of approximately $7,200,000 and $106,000, respectively.
40
<PAGE>
CONNECT, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
13. RELATED PARTY TRANSACTIONS
In November 1993, $2,969,595 of notes payable to stockholders were converted
into Series D preferred stock. Accrued interest outstanding on the notes
payable of $40,116 was also converted into Series D preferred stock.
In June 1994, $668,000 of notes payable to stockholders were converted into
Series E preferred stock. There was no accrued interest outstanding relating
to these notes at the time of conversion.
During 1994, the Company earned license revenue of approximately $900,000
from a related party, of which approximately $10,000 is included in the
accounts receivable balance at December 31, 1994.
During 1995, $126,350 of notes payable to a stockholder were converted into
Series D preferred stock. Accrued interest outstanding on the notes payable of
$26,583 was also converted into Series D preferred stock.
The Company incurred approximately $262,500 and $75,226 in consulting and
other fees to officers and/or stockholders during 1995 and 1994.
14. SUBSEQUENT EVENTS
On January 8, 1997 the Company obtained a commitment for a $2,000,000 line
of credit to be secured by equipment, furniture and fixtures. The Company may
seek advances against the line of credit throughout 1997. Each advance must be
at least $50,000 and secured by specific unencumbered equipment. Amounts
advanced are to be repaid over a period of up to four years at an effective
annual interest rate of approximately 15% per year.
41
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We have audited the financial statements of CONNECT, Inc. as of December 31,
1996 and 1995 and for each of the three years in the period ended December 31,
1996, and have issued our report thereon dated January 24, 1997(included
elsewhere in this Annual Report ( Form 10-K )). Our audits also included the
financial statement schedule listed in Item 14 of this Annual Report ( Form 10-
K ). This schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
Ernst & Young, LLP
San Jose, California
January 24, 1997
42
<PAGE>
SCHEDULE II
CONNECT, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEAR ENDED DECEMBER 31, 1996, 1995, AND 1994
<TABLE>
<CAPTION>
ADDITIONS
BALANCE CHARGED TO
BEGINNING OF COST AND BALANCE AT
PERIOD EXPENSES DEDUCTIONS END OF PERIOD
------------ ---------- ---------- -------------
<S> <C> <C> <C> <C>
Year ended December 31, 1996 $320,000 $157,000 $(255,000) $222,000
Allowance for doubtful
accounts
Year ended December 31, 1995 $174,000 $166,842 $ (20,842) $320,000
Allowance for doubtful
accounts
Year ended December 31, 1996 $ 75,216 $365,967 $(267,183) $174,000
Allowance for doubtful
accounts
</TABLE>
43
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Executive Officers:
The information concerning the Company's Executive Officers is incorporated
by reference from the Proxy Statement for the 1997 Annual Meeting of
Shareholders to be held on May 29, 1997, a copy of which will be filed with
the Securities and Exchange Commission no later than 120 days from the end of
the Company's last fiscal year.
(b) Indentification of Directors:
The information concerning the Company's directors and nominees is
incorporated by reference from the section entitled "Proposal No. 1 - Election
of Directors" in the Proxy Statement for the 1997 Annual Meeting of
Shareholders to be held on May 29, 1997, a copy of which will be filed with
the Securities and Exchange Commission no later than 120 days from the end of
the Company's last fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning the Company's Executive Compensation is
incorporated by reference from the section entitled "Executive Compensation"
in the Proxy Statement for the 1997 Annual Meeting of Shareholders to be held
on May 29, 1997, a copy of which will be filed with the Securities and
Exchange Commission no later than 120 days from the end of the Company's last
fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the section entitled "Stock Ownership of
Certain Beneficial Owners and Management" in the Proxy Statement for the 1997
Annual Meeting of Shareholders to be held on May 29, 1997, a copy of which
will be filed with the Securities and Exchange Commission no later than 120
days from the end of the Company's last fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the section entitled "Certain Relationships
and Related Transactions" in the Proxy Statement for the 1997 Annual Meeting
of Shareholders to be held on May 29, 1997, a copy of which will be filed with
the Securities and Exchange Commission no later than 120 days from the end of
the Company's last fiscal year.
44
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Index to Financial Statements. The following financial statements and
supplemental data are included in Item 8 of this Form 10-K
<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C>
Report of Ernst & Young, LLP, Independent Auditors................. 25
Balance Sheets at December 31, 1996 and 1995....................... 26
Statements of Operations for each of the three years in the period
ended December 31, 1996........................................... 27
Statements of Stockholders' Equity for each of the three years in
the period ended December 31, 1996................................ 28
Statement of Cash Flows for each of the three years for the period
ended December 31, 1996........................................... 29
Notes to Financial Statements...................................... 30
</TABLE>
2. Financial Statement Schedules. Schedule II--Valuation and Qualifying
Accounts
All other schedules are omitted because they are not applicable, or not
required, or because the required information was filed by the Company's
previously, or is included the consolidated financial statements or notes
thereto.
3. Exhibits List
<TABLE>
<C> <S>
1.1 Form of Underwriting Agreement. (1)
2.1 Form of Agreement and Plan of Merger between the Company and Connect,
Inc., a California corporation. (1)
3.1 Certificate of Incorporation of the Company. (1)
3.2 Bylaws of the Company. (1)
3.3 Form of Amended and Restated Certificate of Incorporation of the
Company. (1)
3.4 Certificate of Amendment of Certificate of Incorporation. (1)
4.1 Form of the Company's Common Stock Certificate. (1)
9.1 Amended Stockholders Agreement dated July 3, 1996 by and among the
Company and certain holders of the Company's securities. (1)
10.1 Form of Indemnification Agreement. (1)
10.2 1989 Stock Option Plan, as amended, and form of stock option agreement.
(1)
10.3 1996 Stock Option Plan and form of stock option agreement. (1)
10.4 1996 Employee Stock Purchase Plan and form of subscription agreement.
(1)
10.5 1996 Directors' Stock Option Plan and form of stock option agreement.
(1)
10.6 Amended and Restated Registration Rights Agreement dated July 3, 1996
between the Company and certain holders of the Company's securities. (1)
10.7 Lease Agreement dated September 19, 1994 between the Company and BRE
Properties, Inc. (1)
10.8 Master Equipment Lease dated January 19, 1995 between the Company and
Phoenix Leasing Incorporated. (1)
10.9 Software License Agreement dated February 5, 1996 between the Company
and Entex Information Services Inc. (1)(2)
10.10 Software License Agreement dated March 26, 1996 between the Company and
Union Underwear Company, Inc. (1)(2)
10.11 Software License Agreement dated November 7, 1995 between the Company
and PhotoDisc, Inc. (1)(2)
</TABLE>
45
<PAGE>
<TABLE>
<C> <S>
10.12 Amendment to Software License Agreement dated March 29, 1996 between the
Company and PhotoDisc, Inc. (1)(2)
10.13 Software Development and Distribution License Agreement dated September
16, 1994 between the Company and Fulcrum Technologies Inc. and related
Amending Agreement, amending Agreement No. 2 and Amending Agreement No.
3. (1)(2)
10.14 OEM Master License Agreement dated June 30, 1995 between the Company and
RSA Data Security, Inc. (1)(2)
10.15 Letter Agreement dated May 10, 1995 between the Company and Hambrecht &
Quist Incorporated and related mutual release dated June 6, 1996. (1)
10.16 Option agreement dated January 16, 1996 between the Company and Thomas
P. Kehler. (1)
10.17 Option agreement dated January 16, 1996 between the Company and Gordon
J. Bridge. (1)
10.18 Option agreement dated April 24, 1996 between the Company and Gordon J.
Bridge. (1)
10.19 Letter agreement dated October 19, 1995 between the Company and Gordon
J. Bridge, and related interpretive letter. (1)
10.20 Consulting Agreement dated March 9, 1992 between the Company and
Quaestus Limited Partnership. (1)
10.21 Form of Common Stock Warrant issued to Hambrecht & Quist LLC and Volpe,
Welty & Company on December 27, 1995. (1)
10.22 Business Alliance Program Agreement dated June 11, 1996 between the
Company and Oracle Corporation and related Runtime Sublicense Addendum,
and Amendments One and Two to Runtime Sublicense Addendum. (1)(2)
10.23 Agreement and Mutual Release dated May 24, 1996 between the Company and
Henry V. Morgan. (1)
10.24 Development and License Agreement dated March 29, 1996 between the
Company and Time Warner Cable. (1)(2)
11 Statement Regarding Computation of Pro Forma Net Loss Per Share.
23 Consent of Independent Auditors.
24 Power of Attorney. (see p. 48)
27 Financial Data Schedule.
</TABLE>
- --------
(1) Incorporated by reference to identically numbered exhibits to the
Company's Registration Statement on Form S-1, as amended (File No. 333-
05901), which became effective on August 14, 1996.
(2) Confidential treatment has been previously granted with respect to this
exhibit.
(b) 1. Form 8-K
The Company filed no reports on Form 8-K during the fourth quarter of the
fiscal year 1996.
46
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
CONNECT, Inc.
Date: March 27, 1997 By: /s/ Thomas P. Kehler
-----------------------------------
THOMAS P. KEHLER
President and Chief
Executive Officer, Director
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Thomas P. Kehler and Joseph G. Girata, and each
of them, his attorneys-in-fact and agents, on Form 10-K, and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes may do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Thomas P. Kehler President, Chief Executive March 18, 1997
____________________________________ Officer, Director
(THOMAS P. KEHLER)
/s/ Joseph G. Girata Chief Financial Officer March 18, 1997
____________________________________ (Principal Financial and
(JOSEPH G. GIRATA) Accounting Officer) and Vice
Prsident of Finance &
Administration
/s/ Gordon J. Bridge Chairman of the Board and March 18, 1997
____________________________________ Director
(GORDON J. BRIDGE)
/s/ Promod Haque Director March 18, 1997
____________________________________
(PROMOD HAQUE)
/s/ Richard H. Lussier Director March 18, 1997
____________________________________
(RICHARD H. LUSSIER)
/s/ Terry R. McGowan Director March 18, 1997
____________________________________
(TERRY R. MCGOWAN)
/s/ Rory T. O'Driscoll Director March 18, 1997
____________________________________
(RORY T. O'DRISCOLL)
/s/ Richard W. Weening Director March 18, 1997
____________________________________
(RICHARD W. WEENING)
/s/ William B. Welty Director March 18, 1997
____________________________________
(WILLIAM B. WELTY)
</TABLE>
47
<PAGE>
EXHIBIT 11
CONNECT, INC.
STATEMENT REGARDING COMPUTATION OF PRO FORMA NET LOSS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1996 1995
-------- --------
<S> <C> <C>
Net Loss................................................... $(16,142) $(14,139)
Weighted average common shares outstanding................. 7,299 381
Shares related to SAB No. 64 and 83 (Topic 4, Sec. D)...... 6,643 13,286
Conversion of preferred stock to common stock not included
in shares related to SAB No. 64 and 83 (Topic 4, See D)... 3,969 4,147
-------- --------
Total Shares used in pro forma net loss per share.......... 17,911 17,814
======== ========
Pro forma net loss per share............................... $ (0.90) $ (0.79)
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (
Form S-8 Nos. 333-12791 and 333-21477 ) pertaining to the 1996 Employee Stock
Purchase Plan, 1996 Director's Stock Option Plan, 1989 Stock Option Plan and
1996 Stock Option Plan of CONNECT, Inc. of our reports dated January 24, 1997,
with respect to the financial statements and schedule of CONNECT, Inc.
included in the Annual Report (Form 10-K) for the year ended December 31,
1996.
/s/ Ernst & Young LLP
San Jose, California
March 27 , 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE YEAR
ENDED DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 12,214
<SECURITIES> 0
<RECEIVABLES> 2,534
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 15,354
<PP&E> 6,676
<DEPRECIATION> 3,029
<TOTAL-ASSETS> 19,154
<CURRENT-LIABILITIES> 5,009
<BONDS> 0
0
0
<COMMON> 60,467
<OTHER-SE> (47,112)
<TOTAL-LIABILITY-AND-EQUITY> 19,154
<SALES> 4,693
<TOTAL-REVENUES> 10,180
<CGS> 791
<TOTAL-COSTS> 9,068
<OTHER-EXPENSES> 17,470
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 331
<INCOME-PRETAX> (16,142)
<INCOME-TAX> 0
<INCOME-CONTINUING> (16,142)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (16,142)
<EPS-PRIMARY> (.90)
<EPS-DILUTED> (.90)
</TABLE>
